The International Economy magazine (Winter 2013) asks 16 authorities, “Can Changes in Exchange Rate Valuations Affect Trade Imbalances?“ It is referring to the claim in a recent book by Stanford economist Ron McKinnon that pressure on China to let the renminbi appreciate against the dollar is fundamentally misconceived because such a movement in the exchange rate would not reduce China’s trade surplus nor American’s trade deficit. This is part of an old debate that pre-dates the rise of the China trade problem. Ron has& long claimed that exchange rates don’t determine trade balances because they are “instead” determined by national saving versus investment. I thought PaulKrugmandemolished the argument pretty effectively 25 years ago, with a textbook graph of internal balance versus external balance. But evidently many still fall for the argument (including some of the experts in the TIE symposium). So I try again:
Ron McKinnon has made many important contributions to international macroeconomics over the years. But on this issue, he is simply wrong.
It goes without saying that the current account is equal to the difference between national saving and investment. But it does not follow that we should try to improve the current account in the short run by increasing national saving. Under current conditions, that would send the United States back into recession.
The national saving identity is a tautology: it does not in itself imply causation. True, many of the big movements in the U.S. current account deficit can be explained by changes in national saving: the fiscal expansion of the early 1980s, the investment boom of the late 1990s, and the new fiscal expansion of the 2000s. But the important point is that we care about a lot of things besides just external balance (the trade balance and current account). We care at least as much about internal balance (growth, employment, and inflation). To say that an increase in the budget balance and national saving would improve the trade balance does not imply that this would be good policy or that it is the only way to improve the trade balance.
Of course we need to address the budget deficit in the long run, in balancedsensible ways. But under current circumstances — a still-weak economy, high unemployment, low inflation, rock-bottom interest rates — a reduction in public or private spending would send the economy straight back into recession. That is why the fiscal cliff of January 1, 2013, was such a danger. To observe that the trade balance would have improved if the sharp fiscal contraction had gone fully into effect would have been small consolation for the self-inflicted recession.
The U.S. trade deficit and Chinese trade surplus have diminished and so are today not quite the problems that they were five years ago. But if improving the U.S. trade balance is considered an important goal, then a devaluation or depreciation of the currency is a better tool for the job. (This proposition does not violate the national saving propositions. Nor, on the other hand, does it justify China-bashing.) Because a real devaluation would also raise demand for U.S. products — admittedly with a lag — and thus move us closer to internal balance, it would be a far more appropriate tool for improving the current account under present-day conditions than would cutting national spending or raising taxes.
Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
To have unlimited access to our content including in-depth commentaries, book reviews, exclusive interviews, PS OnPoint and PS The Big Picture, please subscribe
When comparing Ukraine’s situation in 2024 to Europe’s in 1941, Russia’s defeat seems entirely possible. But it will require the West, and the US in particular, to put aside domestic political squabbles and muster the political will to provide Ukraine with consistent and robust military and financial assistance.
compare Russia's full-scale invasion to World War II and see reason to hope – as long as aid keeps flowing.
Current debates about Israeli policy are rife with double standards, leading to absurd decisions like Germany’s recent cancellation of a pro-Palestinian gathering. By quashing legitimate speech and assembly, an Israel-aligned establishment risks inciting precisely the kind of anti-Semitism that it wants to prevent.
worries that the double standards applied on Israel’s behalf will lead to an anti-Semitic backlash.
The International Economy magazine (Winter 2013) asks 16 authorities, “Can Changes in Exchange Rate Valuations Affect Trade Imbalances?“ It is referring to the claim in a recent book by Stanford economist Ron McKinnon that pressure on China to let the renminbi appreciate against the dollar is fundamentally misconceived because such a movement in the exchange rate would not reduce China’s trade surplus nor American’s trade deficit. This is part of an old debate that pre-dates the rise of the China trade problem. Ron has& long claimed that exchange rates don’t determine trade balances because they are “instead” determined by national saving versus investment. I thought PaulKrugmandemolished the argument pretty effectively 25 years ago, with a textbook graph of internal balance versus external balance. But evidently many still fall for the argument (including some of the experts in the TIE symposium). So I try again:
Ron McKinnon has made many important contributions to international macroeconomics over the years. But on this issue, he is simply wrong.
It goes without saying that the current account is equal to the difference between national saving and investment. But it does not follow that we should try to improve the current account in the short run by increasing national saving. Under current conditions, that would send the United States back into recession.
The national saving identity is a tautology: it does not in itself imply causation. True, many of the big movements in the U.S. current account deficit can be explained by changes in national saving: the fiscal expansion of the early 1980s, the investment boom of the late 1990s, and the new fiscal expansion of the 2000s. But the important point is that we care about a lot of things besides just external balance (the trade balance and current account). We care at least as much about internal balance (growth, employment, and inflation). To say that an increase in the budget balance and national saving would improve the trade balance does not imply that this would be good policy or that it is the only way to improve the trade balance.
Of course we need to address the budget deficit in the long run, in balancedsensible ways. But under current circumstances — a still-weak economy, high unemployment, low inflation, rock-bottom interest rates — a reduction in public or private spending would send the economy straight back into recession. That is why the fiscal cliff of January 1, 2013, was such a danger. To observe that the trade balance would have improved if the sharp fiscal contraction had gone fully into effect would have been small consolation for the self-inflicted recession.
The U.S. trade deficit and Chinese trade surplus have diminished and so are today not quite the problems that they were five years ago. But if improving the U.S. trade balance is considered an important goal, then a devaluation or depreciation of the currency is a better tool for the job. (This proposition does not violate the national saving propositions. Nor, on the other hand, does it justify China-bashing.) Because a real devaluation would also raise demand for U.S. products — admittedly with a lag — and thus move us closer to internal balance, it would be a far more appropriate tool for improving the current account under present-day conditions than would cutting national spending or raising taxes.
Subscribe to PS Digital
Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
Subscribe Now