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.Source: Federal Reserve.What if the Dollar Doesn t Fall?The Teflon-like US dollar, of course, seems largely unsympathetic to theurgency of the world s dilemma.After falling by about 6 percent in thefirst six months of 2002, the dollar retraced more than half its descent, asmeasured on a trade-weighted basis against the broadest possible basketof US trading partners (figure 8.5).The dollar currently (mid-December2002) is only 3 percent below its late January highs, hardly enough to spurthe global rebalancing that the world so desperately needs.(It has, however,weakened in the early days of 2003.) While a fundamentally overvalueddollar remains vulnerable to a sharp correction, trading action over thepast year makes it abundantly clear that heightened global angst has thepotential to put any such depreciation on hold.Needless to say, that s hardlya trivial consideration in light of intensified concerns over the possibility ofa US double-dip recession and a war in Iraq.In a US-centric global economy,there is no   growth premium  for the rest of the world in the event ofan American recessionary relapse.And a war in the Middle East and itsconcomitant threat to world oil supplies appears to have   safe haven written all over it.For those reasons alone, the dollar may prove to bestubbornly resistant on the downside thereby closing off the last optionfor an unbalanced global economy to find a new equilibrium.Should the US dollar fail to correct, the noose can only tighten on ashaky global economy.Global rebalancing will then have to be ventedby sharp corrections in other US assets, notably stocks and/or bonds.America will then find itself stuck between deflation and the unrelentingpressures of its postbubble excesses, and the rest of the world will finditself unduly dependent on the whims of an ever-fickle US growthdynamic.Nor will there be any realistic options for global policymakersALL EYES ON THE DOLLAR 171Copyright 2003 Institute for International Economics | http://www.iie.com to find a benign solution to this unrelenting buildup of global tensions.In the end, a long overdue rebalancing of a US-centric global economyis really the only way out.I continue to believe that a significant deprecia-tion of the dollar offers the most realistic and least painful avenue forresolution.I remain convinced that, one way or another, the currentdisequilibrium in the global economy will eventually force a newequilibrium.Gauging the ImpactsMartin Baily s paper in this volume confirms many of the conceptualpoints I have made above as far as the macro impact of a weaker dollarin concerned.I have to confess that I ve never been too sympathetic to softlandings.Instead, I prefer the   fast dollar decline  scenario he describes asa more realistic assessment of what lies ahead.In that simulation, Bailyfinds that a 20 percent drop in the value of the dollar would reduce thelevel of real GDP by 1.2 percent by 2007, with personal consumptiondown over 5 percent and capital spending down nearly 12 percent overthe same period.Higher interest rates would be the precipitating factorin this demand adjustment, with the federal funds rate going back to 10percent over the next five years.One of his most important findings isthat a sharp decline in the value of the dollar raises the CPI-based inflationrate by one full percentage point over each of the next five years.Suchan outcome could well make a real difference in staving off deflationarypressures currently bearing down on the United States.The one surprise in Baily s analysis is that the rest of the world doesn tdo any better than the United States.However, a key assumption in thisaspect of his research is that no meaningful policy actions are taken byforeign economies in order to stimulate their domestic demand.I remainhopeful that such actions will occur, as a dollar correction triggers theprogrowth reforms noted above in effect, sparking a global rebalancingthat leads to a delinking of the rest of the world from the US economy.The good news is that, even if that s not the case, Baily estimates that theUS current account deficit would be cut in half, thereby returning to 2.5percent of GDP over the next five years.Needless to say, if I m right anddollar weakness triggers progrowth policies elsewhere in the world, theUS external deficit would undoubtedly shrink a good deal more.Other Policy ActionsOf course I do not believe a weaker dollar is a panacea for all that ailsthe US or the global economies.Nor do I believe in competitive currencydevaluation as a means toward any end.Yet an unbalanced world needs172 DOLLAR OVERVALUATION AND THE WORLD ECONOMYCopyright 2003 Institute for International Economics | http://www.iie.com a realignment of relative prices, and a weaker dollar is the most sensibleway to achieve this, in my opinion.It also happens to be the one optionwith the greatest potential to stave off America s deflationary endgame.But the dollar certainly can t do the job alone.Additional Fed policystimulus may well be required to trigger this adjustment in the dollar.Such easing would reinforce the dollar-correction scenario I have in mind,but it would also be helpful in putting a floor on US domestic demandyet another remedy to contain deflation.Nor would I shy away fromanother dose of fiscal stimulus in this climate, especially tax cuts aimedat middle-income workers.The odds of outright deflation are now high enough, in my view, forpolicymakers to take extraordinary actions to prevent it.As the Fed sown research staff has duly noted, that s a key lesson from the Japaneseexperience that should not be lost on the United States or, for that matter,on any industrial economy.1 There s always a risk that these actions mightcome too late to make a real difference for a postbubble economy.But atthis point in time, the bigger risk comes from doing nothing.The timeto act is now.A lopsided world economy on the brink of deflation needs a majorpolicy fix.Tensions on this order arise rarely.And they require a radicalrethinking of policy options [ Pobierz całość w formacie PDF ]

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