The SanityPrompt

This blog represents some small and occasional efforts to add a note of sanity to discussions of politics and policy. This blog best viewed with Internet Explorer @ 1024x768

Thursday, March 03, 2005

So is the sky falling or rising?

A recent report from the Minnesota Fed by Hilary Croke, Steven B. Kamin and Sylvain Leduc suggests that a collapse of the dollar is unlikely to have the dire economic consequences forecast by those I have cited recently including Thomas Friedman, Brad DeLong, Nouriel Roubini, Brad Setser, and others. This is from their abstract:
"We found little evidence among past adjustment episodes of the features highlighted by the disorderly correction hypothesis. Although some episodes in our sample experienced significant shortfalls in GDP growth after the onset of adjustment, these shortfalls were not associated with significant and sustained depreciations of real exchange rates, increases in real interest rates, or declines in real stock prices. By contrast, it was among the episodes where GDP growth picked up during adjustment that the most substantial depreciations of real exchange rates occurred. These findings do not preclude the possibility that future current account adjustments could be disruptive, but they weaken the historical basis for predicting such an outcome."

They're not the only ones. Brad DeLong reports on the work of Olivier Blanchard, Francesco Giavazzi, and Filipa Sa. I can't comment on that research but Brad DeLong does a good job. I haven't read the Fed report in great depth but I can raise a numnber of questions. Their data draw from 23 or so instances in the last two decades of 'current account adjustments' among industrialized countries. This raises some concern on my part siunce they include 1987 and the stock market crash in the US. Bet you didn't know that was a current account adjustment did you? I think this is an instance of social science struggling to make square data fit a round hole. I am not sure that all of the instances they cite give us much insight into what is likely to happen if there is a run on the US dollar. For one thing, the experiences of Austria, Belgium, Greece, and Portugal are unlikely to be similar to that of the US. For another, none of the nations in the list found themselves in a situation where over 40% of their reserves were held by foreigners and where two nations held almost 40% of their dollars. What the authors are talking about are runs on a currency. What DeLong, Roubini, and others are concerned about are a stampede on the dollar. Very different things.

The authors suggest as much at the end of their paper when they also acknowledge:
"Finally, the U.S. current account deficit, at present, is already larger than it was for the average of the episodes in our sample....However, the size of the deficit likely increases the extent of external adjustment that might be required in the future."



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