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+Reynolds 1989 Fed Testimony

+Reynolds 1989 Fed Testimony

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Published by Alan Reynolds
I testified on international issues, including debt crises and the dollar, at a Federal Reserve Board committee on April 14, 1989. Is any of this relevant to global issues today? Maybe so.
I testified on international issues, including debt crises and the dollar, at a Federal Reserve Board committee on April 14, 1989. Is any of this relevant to global issues today? Maybe so.

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Published by: Alan Reynolds on Oct 31, 2011
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1International Economic Policy:Choices, Problems and Opportunities for the Bush AdministrationTestimony Before TheSystem Committee on International Economic AnalysisBoard of GovernorsFederal Reserve SystemApril 14, 1989Alan ReynoldsVice President & Chief EconomistPolyconomics Inc.Morristown, N.J.
 
 
2The Bush Administration faces several uniquely challenging tasks ininternational economic policy -- coordinating monetary and exchange ratepolicies with other G-7 nations, helping Latin America and African economiesstop inflation and revive economic expansion, and adapting constructively tointegration in Europe and perestroika in the Soviet Union. There have beenmany suggestions that certain policies or objectives be assigned "toppriority," yet the acutal top priority must be avoiding recession orinflation. Although a recession might reduce the trade deficit, it wouldsurely increase the budget deficit. And although a weaker dollar mightconceivably reduce the trade deficit, it would surely increase inflation.Policies that threaten recession or inflation are to be avoided, regardlessof their promised effects on budget or trade deficits.Neither the national debt or foreign debt of the United States areparticularly large. Yet it is important to improve longer-term confidencethat these debts will be financed in a non-inflationary way. The effort of G-7 central banks to stablize exchange rate expectations can be helpful in thisrespect, particularly if it leads toward openly announced, credible long-termcommitments. By itself, though, an exchange rate indicator for monetarypolicy cannot determine which country should do what. The recent appreciationof the dollar, for example, might indicate that U.S. monetary policy is tootight, or that foreign monetary policy is too loose. To resolve suchquestions, serious consideration should be given to more explicit use ofsensitive prices of internationally traded commodities as an early indicatorof incipient inflation or deflation, as Governor Wayne Angell, formerTreasury Secretary James Baker and the Toronto Summit proposed. "The price ofgold should be included...because of the historic and widespread perceptionof gold as an indicator of a flight from currency," as Chairman GreenspanReynolds, Alan, "Wake Up to the New Monetary Order" Institutional Investor(September 1988); Branson, William H. & Boughton James M., "Commodity Pricesas a Leading Indicator of Inflation" NBER Working Paper No. 2750 (1989).
 
 
3observed. When world commodity prices appear inflationary, countries withdeclining currencies should tighten money; when the world situation looksdeflationary, countries with rising currencies should ease. To the extentthat exchange rate risk and global inflation risk can thus be minimized,investors will become relatively indifferent between, say, U.S. or Japanesebonds. Long-term interest rates should then converge toward a similar, lowlevel, allowing less onerous refinancing of troublesome dollar-denominateddebts, at home and abroad.The BudgetSo long as the U.S. is operating at high employment, a slowdown in thegrowth of government purchases and government-financed consumption would helpfree-up real resources, such as energy and labor, to expand privateproduction. An increase in taxation, on the other hand, does not free-upresources for private production, but instead permanently transfers privateresources toward government services (which are quite difficult to export).The United Kingdom and Australia moved from budget deficit to surplusin the past few years, yet nonetheless have sizable current account deficits,high inflation and extremely high interest rates. Clearly, there is noautomatic link between budget and trade deficits, or between budget deficitsand inflation. The "policy mix" idea -- the theory that higher taxes are asubstitute for prudent monetary policy -- is a proven recipe for stagflation.Easy money simply stimulates nominal GNP (demand), while higher tax ratessuffocate real GNP (supply).Many economists who did not anticipate the U.S. current account deficitnonetheless confidently "project" that it will continue indefinitely. Theusual policy conclusion is that the dollar should be repeatedly devalued.Greenspan, Alan, "Testimony" House Subcommitee on Domestic Monetary Policy,December 18, 1987."One view, frequently expressed by economists residing in Cambridge,Massachusetts, is that a sustainable external balance would not be achievedwithout a substantial further decline in the dollar....These modelextrapolations may be overly pessimistic inasmuch as they fail to capturepotentially significant longer-run adjustments on the supply side." Hooper,Peter, "Exchange Rates and U.S. External Adjustment in the Short Run and the

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