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Saturday, March 15, 2008

Martin Feldstein: The European $afety Net

Martin Feldstein on the impact of the falling dollar:

The European $afety Net, by Martin Feldstein, Project Syndicate: When the euro's value reached an all-time high of $1.52, the president of the European Central Bank, Jean-Claude Trichet, told the press that he was concerned ... and wanted to "underline" the United States Treasury's official policy of supporting a strong dollar. Several European finance ministers subsequently echoed a similar theme.

In reality, of course, America does not have a dollar policy — other than letting the market determine its value. The American government does not intervene in the foreign exchange market to support the dollar...

Nevertheless, all U.S. Treasury secretaries, going back at least to Robert Rubin in the Clinton administration, have repeated the mantra that "a strong dollar is good for America"... Indeed, the Treasury's only explicit currency goal now is to press the Chinese to raise the value of the renminbi... The pressure on China is, however, entirely consistent with the broader American policy of encouraging countries to allow the financial market to determine their currencies' exchange rate....

[W]hile the declining dollar does reduce Americans' purchasing power, the magnitude of this effect is not large, because imports account for only about 15% of U.S. gross domestic product. A 20% dollar depreciation would therefore reduce Americans' purchasing power by only 3%. At the same time, the lower dollar makes American products more competitive in global markets, leading to increased exports and reduced imports. ...

On a real trade-weighted basis, the dollar is down about 13% relative to its value in March 2006. This improved competitiveness of American goods and services is needed to shrink the massive American trade deficit. ... [T]he dollar must fall substantially further to shrink the trade deficit to a sustainable level. ...

Instead of simply wishing that the dollar would stop falling, European governments need to take steps to stimulate domestic demand to replace the loss of sales and jobs that will otherwise accompany the more competitive dollar. This is not an easy task, because the European Central Bank must remain vigilant about rising inflation, and because many E.U. countries maintain large fiscal deficits.

While the ECB has limited room for maneuver, regulatory changes, and revenue-neutral shifts in the tax structure (for example, a temporary investment tax credit financed by a temporary increase in the corporate tax rate) could provide the stimulus needed to offset declining net exports. It is therefore important that E.U. governments turn their attention to this challenge.

Marty Feldstein was in the news yesterday:

Marty is scared, by Greg Mankiw: Reuters reports:

The United States is in a recession that could be "substantially more   severe" than recent ones, National Bureau of Economic Research President   Martin Feldstein said on Friday. "The situation is very bad, the situation is   getting worse, and the risks are that it could get very bad."... Feldstein said the downturn could be the worst in the United States since   World War Two.

Feldstein was in competition with Ben Bernanke to head the Fed after Greenspan. Think he's glad he escaped this turmoil, or if he wishes he could lead the Fed in this crisis? Probably some of both.

    Posted by on Saturday, March 15, 2008 at 12:15 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (15)


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