International Finance and Financial Policy

By Hans R. Stoll | Go to book overview

the appreciation of the U.S. dollar in the 1980-85 period, rather than from a level of U.S. spending in excess of U.S. productive capacity. The key question is whether the appreciation of the U.S. dollar during this. period can be attributed to a demand-side phenomenon--the autonomous increase in the foreign demand for U.S. dollar securities--or to a supply side phenomenon--the increase in interest rates on U.S. dollar securities due to the more expansive U.S. fiscal policy. A second shortcoming of the traditional view is that the increase in the foreign demand for U.S. dollar securities occurred when interest rates on U.S. dollar securities were declining and the foreign exchange value of the U.S. dollar was increasing; together these two financial market developments suggest that the increase in the foreign demand for U.S. dollar securities was autonomous rather than a response to the increases in the volume of U.S. dollar securities extant.

The increase in the U.S. trade deficit that resulted from the increase in the foreign demand for U.S. dollar securities was a major cause of the U.S. fiscal deficit. The direct impact was that increased U.S. spending on imports meant that the levels of U.S. production and employment and tax collections were increasing less rapidly than the aggregate level of U.S. spending. The indirect impact was the policy response that to reduce or offset the "imported unemployment," U.S. government expenditures were increased relative to U.S. fiscal revenues at all levels of income.

The U.S. trade and current account deficits are too large to be sustained for an indefinite future; foreign-owned U.S. dollar assets are increasing too rapidly relative to U.S. national income. Still these U.S. deficits may remain excessively large for an extended period, or for as long as the convenience of the trade surplus countries is suited. The longer the trade deficit remains exceptionally large, the greater the risk to the United States of an inflationary shock if the foreign demand for U.S. dollar assets should decline more abruptly than the U.S. ability to increase the output of manufactured goods.

The traditional macro policy measures are not likely to prove effective in reducing the U.S. trade deficit, and neither is an increase in the U.S. saving rates. Although these measures may lead to a reduction in interest rates on U.S. dollar assets, the foreign demand for these assets is likely to remain strong, because foreign interest rates will decline almost as rapidly as U.S. dollar interest rates. Hence direct measures may be necessary to segment the U.S. financial markets from foreign financial markets, or to otherwise reduce the U.S. trade deficit to a sustainable level in an orderly way.


NOTES
1.
That the U.S. trade balance adjusts to provide consistency for the trade balances of all other countries is one facet of the assignment problem. Thus in a two-currency world, there is only one exchange rate (see Sohmen, 1969).
2.
Indeed, as the U.S. dollar depreciates, the foreign demand for U.S. dollar securi-

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