Edward Renshaw
Professor of Economics
State University of New York at Albany
The economies of the US and the rest of the world have become more interdependent. Imports from other countries amounted to only 4.4 percent of U.S. GDP in 1959. By 1994 the share of imports had increased by more than 2.5 times to 11.8 percent of nominal GDP. The rapid growth of trade has lowered the autonomous expenditure multiplier for the US (which was discussed in Essay 1) and made it more desirable for the industrialized nations of the world to coordinate their economic policies.
When the U.S. enters an economic recession imports of goods and services usually decline more rapidly than U.S. exports of goods and services. This slows the growth of economic activity in other countries and may tip some of them into a recession of world wide proportions. Once a recovery is underway U.S. imports tend to rise more rapidly than U.S. exports. This, in turn, has helped to slow the recovery from a recession and lift other countries out of the recession. See column (1) of Table 16.1.
Some of our trade deficits, such as that for automobiles, are too large to be sustainable in the long run. At some point in the not too distant future we will also have to reduce our consumption of imported oil.
The emergence of large trade deficits in association with huge government deficits in the national income and product accounts has inspired the notion of "twin deficits". See columns (2) and (4) of Table 1.2 in Essay 1 for an impression of the extent to which this idea has been consistent with the historical data.
Starting with the accounting principle that leakages must equal injections we can easily determine the conditions that would make these two deficits identical. Where Im represents imports and X stands for exports, we have:
S + T + Im = I + G + X (1)
If domestic savings equal domestic investment (S = I), the variables in our leakage equals injection equation can be rearranged to show that the trade deficit (X - Im) will be equal to the government deficit (G - T). The risk that a country runs in having a large budget deficit that is financed by foreign borrowing is that unfavorable changes in the exchange rate (or value of the dollar) will eventually begin to correct the trade deficit and cause the budget deficit to "crowd out" domestic investment as well as imports from other countries.
At some point in the future the U.S. may have to export more than it imports to pay interest on the government debt owed to foreigners. The perceived need for more investment to produce the added exports, if they are not to be at the expense of less production for domestic consumption, may force the government to eventually raise taxes or lower government expenditure to reduce the deficit.
The tendency for economic recessions to begin in the United States and then spread to other countries can be verified by examining the year-to-year growth rates for industrial production in Table 16.2. The recession of 1990-91 was somewhat unique, however, since it appears to have got underway in Canada and the United Kingdom before the United States. Once an economic recovery has begun, industrial production has usually increased faster, for a time, in the U.S. than in most other industrialized countries.
What stands out even more clearly in this table, however, is a marked propensity for declines and periods of sub-par growth in industrial production to become longer and more protracted, on the average, in most countries beginning in the 1980s. The data, in any event, are not inconsistent with the hypothesis that prolonged recessions have become a worrisome problem as far as the more industrialized countries are concerned.
The evidence in support of international cooperation to solve an economic problem is most apparent in connection with consumer price inflation. The double digit inflation which existed in most industrialized countries after the oil price shock of January 1974 has disappeared. From 1991-94 the differences in the inflation rates for the G-7 countries in Table 16.3 were less than existed before President Nixon took the U.S. off the international gold standard in August 1971. The lower inflation rates can probably be attributed to coordinated monetary policies and a goal on the part of the European Economic Community to eventually create a common currency unit.
The impression one obtains from Tables 16.3 and 16.4 is that the central banks of France, the United Kingdom and, to a lesser extent, Italy have been willing to let their country's unemployment rates soar to very uncomfortable levels to bring inflation down and further the goal of European monetary integration. Now that the disparities in inflation rates have been substantially reduced and Germany has been successful at moderating the upward surge in consumer prices associated with reunification it may be possible for central bankers to cooperate in an attempt to rescue the more industrialized world from anemic growth and reduce the risk of political instability that is associated with unemployment rates which have risen to double digit levels in some countries.
While trade deficits and differing inflation rates are likely to affect the value of the dollar it is difficult to forecast changes in currency rates on a year-to-year basis. If there is a cyclical pattern to the behavior of the dollar relative to the currencies of most other industrialized nations, this analyst has failed to discover it.
Fluctuations in the multilateral trade weighted value of the dollar were modest until after President Nixon took the US off the international gold standard in 1971. The trend, thereafter, was negative until the passage of the Economic Recovery Tax Act of 1981. It then soared upward for five consecutive years before plunging downward to nearly the same level in 1990 as in 1980 (Table 16.5).
A strong dollar is preferred by the Federal Reserve to a weak dollar which can add to inflationary pressures in this country as a result of higher import prices and by creating a less competitive climate where it is easier for manufacturing enterprises in the U.S. to raise their prices. In 1995 U.S. monetary authorities intervened in the foreign exchange markets on eight occasions to help prop up the value of the German mark and the Japanese yen.
It is by no means clear, however, that central banks can really stabilize foreign exchange rates. Catherine Bonser-Neal (1996) of the Federal Reserve Bank of Kansas City has examined efforts to stabilize the value the dollar relative to the value of both the mark and the yen from 1985-91 and concluded, "The evidence suggests that central bank intervention does not generally reduce exchange rate volatility."
The inflation adjusted returns on bank deposits for the United States, Germany, Japan and the United Kingdom have varied considerably over time and across countries since the economic recession of 1981-82. See Table 16.6. The United States had the highest adjusted returns on deposits from 1983-89 but was more aggressive in lowering short term interest rates in response to anemic growth of industrial production from 1990-93 than Germany, Japan and the United Kingdom.
Since the oil price recovery and shock years of 1989-90 there has been a fairly dramatic convergence of inflation adjusted returns on bank deposits in spite of the inflationary pressures arising from the reunification of East and West Germany in October 1990. There are some economists who believe that long term interest rates are already determined in a global market place and that the role of central banks is to simply ratify changes that are dictated by shifts in the world wide demand for and supply of credit.
Bonser-Neal, Catherine (1996). "Does Central Bank Intervention Stabilize Foreign Exchange Rates?" Federal Reserve Bank of Kansas City Economic Review, (First Quarter), 43-57.
Year Total Oil Auto Grants Travel Cap Ind Ag Inv Other
Goods Sup Prod Inc
(1) (2)n (3)n (4)n (5)n (6)n (7)n (8)n (9)n (10)n
1965 5.4 -2.0 1.0 -4.6 -1.3 6.6 -1.5 2.1 5.4 - .3
1966 3.0 -2.1 .6 -5.0 -1.3 6.7 -2.0 2.4 5.0 -1.3
1967 2.6 -2.1 .4 -5.3 -1.8 7.4 -1.5 1.9 5.3 -1.7
1968 .6 -2.4 - .5 -5.6 -1.5 8.3 -2.4 1.3 6.0 -2.6
1969P .4 -2.6 -1.0 -5.7 -1.8 9.0 -1.5 1.1 6.0 -3.1
1970T 2.3 -2.9 -1.6 -6.2 -2.0 10.7 - .1 1.5 6.2 -3.3
1971R -1.4 -3.7 -2.7 -7.4 -2.3 11.1 -2.9 1.9 7.3 -2.7
1972 -5.8 -4.7 -3.2 -8.5 -3.1 11.0 -4.4 2.9 8.2 -4.0
1973P 7.1 -8.4 -3.4 -6.9 -3.2 13.7 -2.6 9.3 12.2 -3.6
1974 2.0 -26.6 -3.4 -9.2 -3.2 21.1 -1.5 11.7 15.5 -2.4
1975T 18.1 -27.0 -1.1 -7.1 -2.8 26.4 2.8 12.6 12.8 1.5
1976R 4.3 -34.6 -4.1 -5.7 -2.6 26.8 -1.4 12.0 16.1 -2.2
1977 -14.3 -45.0 -5.2 -5.2 -3.6 25.8 -5.9 10.2 18.1 -3.5
1978 -15.1 -42.6 -9.8 -5.8 -3.6 28.2 -6.5 14.6 20.4 -10.0
1979P - .3 -60.4 -8.7 -6.6 -2.9 35.6 4.7 18.0 30.9 -10.9
1980T 2.3 -79.5 -10.9 -8.3 -1.0 44.7 12.1 23.8 30.1 - 8.7
1981P 5.0 -78.4 -11.3 -11.7 .1 47.1 7.5 26.4 32.9 - 7.6
1982T -11.4 -62.0 -17.1 -17.1 -1.0 38.1 9.1 21.3 29.8 -12.3
1983R -44.0 -55.1 -24.5 -17.7 -4.2 28.0 -1.0 19.6 31.5 -20.7
1984 - 99.0 -58.1 -34.1 -20.6 -8.4 16.6 -9.3 18.5 20.7 -24.3
1985 -124.2 -51.4 -40.0 -23.0 - 9.8 18.0 -7.8 9.1 20.6 -39.9
1986 -150.9 -34.3 -53.0 -24.2 - 8.5 10.8 -10.5 4.7 12.9 -48.8
1987 -166.3 -42.9 -57.6 -23.1 - 7.6 7.6 -7.1 8.3 9.5 -53.4
1988 -127.1 -39.6 -54.5 -25.0 -2.6 16.9 - .5 16.1 13.3 -51.3
1989 -103.8 -50.9 -52.5 -26.1 4.0 26.7 7.3 18.2 13.7 -44.2
1990P - 92.7 -62.3 -52.0 -33.4 8.0 36.4 14.0 16.6 20.7 -40.7
1991T - 7.4 -51.7 -45.7 6.9 17.0 45.7 20.5 16.5 15.1 -31.7
1992R - 61.5 -51.6 -44.8 -32.1 20.5 41.8 12.7 18.3 10.1 -36.4
1993 - 99.9 -51.5 -50.0 -34.1 19.9 29.8 4.0 17.6 9.0 -44.6
1994 -151.2 -51.3 -60.7 -35.8 19.3 21.0 -1.0 18.9 -9.3 -52.3
Footnotes to Table 16.1
P identifies a year containing a peak in economic activity.
T identifies a year containing a recessionary trough in economic activity.
R identifies a year of sustained recovery in economic activity following a recessionary trough.
(2)n. Imports of crude oil and petroleum products.
(3)n. Net exports of automotive products.
(4)n. Net unilateral transfers of goods and services from the US to other countries including military grants.
(5)n. Net travel and transportation receipts.
(6)n. Net exports of nonautomotive capital goods.
(7)n. Net exports of industrial supplies and materials.
(8)n. Net exports of agricultural commodities.
(9)n. Net investment income.
(10)n. Column (1) minus columns (2) through (9). This deficit is mainly due to the importation of more consumer goods than are exported from the US to other counties.
Source of basic data: Economic Report of the President.
Year US Canada Japan France Germany Italy UK 1968 5.6 6.3* 15.2* 1.6 9.2* 5.8* 7.7* 1969P 4.6 7.0* 15.8* 11.3* 12.7* 3.7 3.4 1970T -3.3 1.2* 13.9* 4.3* 6.5* 6.4* .5* 1971R 1.3 5.4* 2.7* 6.9* 2.0* - .4 - .5 1972 9.8 7.6 5.5 5.2 3.8 4.1 1.8 1973P 8.1 10.6* 13.9* 7.4 6.4 9.7* 8.9* 1974 -1.5 3.1* -2.2 3.4* - .2* 4.5* -1.8 1975T -8.8 -5.9* -10.5 -7.8* -6.1* -9.2 -5.4* 1976R 9.2 6.1 11.1* 8.4 9.0 12.5* 3.2 1977 8.0 4.3 3.9 2.2 1.4 1.1 5.0 1978 5.6 3.5 6.4* 2.2 2.7 1.9 2.9 1979P 3.8 4.9* 7.0* 5.3* 4.8* 6.7* 3.9* 1980T -1.9 -3.8 4.6* - .1* .3* 5.6* -7.2 1981P 1.9 2.1* 1.1 - .6 -1.9 -1.5 -3.2 1982T -4.4 -9.8 .4* -1.0* -3.1* -3.2* 1.9* 1983R 3.7 6.6* 3.1 - .8 .7 -3.3 3.7 1984 9.3 12.1* 9.2 .6 2.9 3.4 .1 1985 1.7 5.6* 3.6* .1 4.5* 1.2 5.5* 1986 1.0 - .7 - .2 .8 1.9* 3.6* 2.4* 1987 4.9 4.8 3.4 2.0 .4 4.0 4.0 1988 4.4 5.3* 9.4* 4.6* 3.9 5.9* 4.8* 1989 1.5 - .1 5.8* 4.1* 4.7* 3.1* 2.1* 1990P .0 -3.3 4.2* 1.9* 5.2* .2* - .3 1991T -1.7 -4.2 1.9* - .0* 3.7* - .9 -3.7 1992R 3.4 1.1 -5.8 -1.2 -2.0 - .2 - .1 1993 3.5 4.5* -4.1 -3.7 -7.7 -2.5 1.9 1994 5.9 6.5* 1.2 5.1 3.2 4.9 5.1 1995 3.2
*Years when the growth of industrial production in another country exceeds the US growth rate.
P identifies a year containing a US peak in industrial production.
T identifies a year containing a US trough in industrial production.
R identifies a year of sustained recovery in industrial production after a recessionary trough.
Source of basic data: Economic Report of the President.
Year US Canada Japan France Germany Italy UK Spread 1968 4.2 3.8 5.6* 4.5* 1.6 1.2 4.9* 4.4 1969 5.5 4.6 5.3 6.6* 1.8 2.5 5.2 4.8 1970 5.7 3.2 7.5* 4.7 3.7 1.2 6.9* 6.3 1971 4.4 2.8 6.2* 5.6* 5.1* 4.8* 9.2* 6.4 1972 3.2 5.0* 4.9* 6.3* 5.6* 6.2* 7.1* 3.9 1973 6.2 7.4* 11.7* 7.1* 7.0* 10.2* 9.4* 5.5 1974 11.0 11.1* 23.2* 13.9* 7.0 19.4* 15.8* 16.2 1975 9.1 10.8* 11.9* 11.7* 6.0 17.1* 24.5* 18.5 1976 5.8 7.4* 9.2* 9.6* 4.2 16.7* 16.4* 12.5 1977 6.5 8.0* 8.2* 9.6* 3.6 19.3* 15.8* 15.7 1978 7.6 9.0* 4.2 9.1* 2.7 12.5* 8.3* 9.8 1979 11.3 9.2 3.7 10.6 4.2 15.5* 13.5* 11.8 1980 13.5 10.1 7.8 13.7 5.5 21.3* 17.9* 15.8 1981 10.3 12.5* 5.0 13.4* 6.2 19.3* 12.0* 14.3 1982 6.2 10.9* 2.7 11.7* 5.2 16.3* 8.5* 13.6 1983 3.2 5.8* 1.9 9.7* 3.4* 14.9* 4.6* 13.0 1984 4.3 4.4* 2.2 7.4* 2.4 10.6* 5.0* 8.4 1985 3.6 3.9* 2.1 5.8* 2.1 8.6* 6.0* 6.5 1986 1.9 4.1* .7 2.6* - .2 6.1* 3.4* 6.3 1987 3.6 4.4* .1 3.2 .2 4.6* 4.2* 4.5 1988 4.1 4.1 .7 2.7 1.3 5.0* 4.9* 4.3 1989 4.8 5.0* 2.3 3.5 2.7 6.6* 7.8* 5.5 1990 5.4 4.8 3.1 3.4 2.7 6.1* 9.5* 6.8 1991 4.2 5.6* 3.2 3.2 3.5 6.5* 5.9* 3.3 1992 3.0 1.5 1.7 2.5 4.0* 5.3* 3.7* 3.8 1993 3.0 1.9 1.4 2.1 3.6* 4.2* 1.6 2.8 1994 2.6 .2 .7 1.7 2.7* 3.9* 2.4 3.7 1995 2.8 2.2 - .1 1.7 1.7 5.4* 3.5* 5.5
The spread is equal to the highest inflation rate minus the lowest inflation rate for the seven industrialized countries.
*Years when the inflation rate for the consumer price index was higher than in the US.
Source of basic data: Economic Report of the President.
Year US Canada Japan France Germany Italy UK
1965 4.5 3.6 1.2 1.6 .3 3.5 2.1
1966 3.8 3.4 1.4 1.6 .3 3.7 2.3
1967 3.8 3.8 1.3 2.1 1.3 3.4 3.3
1968 3.6 4.5* 1.2 2.7 1.1 3.5 3.2
1969 3.5 4.4* 1.1 2.3 .6 3.5 3.1
1970 4.9 5.7* 1.2 2.5 .5 3.2 3.1
1971 5.9 6.2* 1.3 2.8 .6 3.3 3.9
1972 5.6 6.2* 1.4 2.9 .7 3.8 4.2
1973 4.9 5.5* 1.3 2.8 .7 3.7 3.2
1974 5.6 5.3 1.4 2.9 1.6 3.1 3.1
1975 8.5 6.9 1.9 4.1 3.4 3.4 4.6
1976 7.7 7.1 2.0 4.5 3.4 3.9 5.9
1977 7.1 8.1* 2.0 5.1 3.4 4.1 6.4
1978 6.1 8.3* 2.3 5.3 3.3 4.1 6.3*
1979 5.8 7.4* 2.1 6.0* 2.9 4.4 5.4
1980 7.1 7.5* 2.0 6.4 2.8 4.4 7.0
1981 7.6 7.5 2.2 7.6 4.0 4.9 10.5*
1982 9.7 11.0* 2.4 8.3 5.6 5.4 11.3*
1983 9.6 11.8* 2.7 8.5 6.9 5.9 11.8*
1984 7.5 11.2* 2.8 10.0* 7.1 5.9 11.8*
1985 7.2 10.5* 2.6 10.4* 7.2 6.0 11.2*
1986 7.0 9.5* 2.8 10.6* 6.6 7.5* 11.2*
1987 6.2 8.8* 2.9 10.7* 6.3* 7.9* 10.3*
1988 5.5 7.8* 2.5 10.2* 6.3* 7.9* 8.6*
1989 5.3 7.5* 2.3 9.6* 5.7* 7.8* 7.3*
1990 5.5 8.1* 2.1 9.1* 5.0 7.0* 7.0*
1991 6.7 10.4* 2.1 9.6* 4.3 6.9* 8.9*
1992 7.4 11.3* 2.2 10.5* 4.6 7.3 10.1*
1993 6.8 11.2 2.5 11.9* 5.7 10.3* 10.5*
1994 6.1 10.4 2.9 12.7* 6.5* 11.4* 9.6*
1995 5.6 9.5 3.2 12.3* 6.6* 12.1* 8.8*
1993 6.8 11.2* 2.6 11.2* 6.1 10.6* 10.4*
*Years when the unemployment rate was higher than in the US.
Source of basic data: Economic Report of the President.
Multilateral High-
Year Canada French German Italian Japan UK Trade Weighted Low
Dollar Frank Mark Lira Yen Pound Dollar Value Spread
(1) (2) (3) (4) (5) (6) (7) (8)n
1968 - .1 .7 .1 - .0 - .4 -13.0 1.8 13.7
1969P - .1 5.0 -1.7 .6 - .6 - .1 .2 6.7
1970T -3.0 6.3 -7.1 - .0 - .1 .2 -1.1 13.4
1971 -3. - .3 -4.5 -1.4 -2.9 2.0 -2.7 6.5
1972 -1.9 -8.4 -8.5 -5.6 -12.8 2.4 -7.4 15.2
1973P 1.0 -11.7 -16.2 - .2 -10.5 -2.0 -9.2 17.2
1974 -2.2 8.0 -3.2 11.7 7.6 -4.6 2.3 16.3
1975T 4.0 -10.9 -4.8 .4 1.7 -5.1 -2.9 14.9
1976 -3.1 11.5 2.3 27.6 - .1 -18.8 7.3 46.4
1977 7.8 2.8 -7.7 5.9 -9.4 -3.3 -2.2 17.2
1978 7.3 -8.3 -13.5 -3.8 -21.7 9.9 -10.6 31.6
1979P 2.7 -5.6 -8.7 -2.1 4.1 10.6 -4.7 19.3
1980T - .2 - .7 - .9 3.0 3.5 9.5 - .8 10.4
1981P 2.5 28.7 24.5 33.0 -2.6 -12.9 18.3 45.9
1982T 3.0 21.0 7.3 18.9 12.9 -13.6 12.8 34.6
1983 .0 15.8 5.2 12.2 -4.6 -13.3 7.5 29.1
1984 5.1 14.6 11.4 15.6 - .0 -11.8 10.3 27.4
1985 5.5 2.8 3.4 8.7 .4 -2.9 3.5 11.6
1986 1.7 -22.9 -26.2 -21.9 -29.4 13.1 -21.5 42.5
1987 -4.6 -13.2 -17.2 -13.0 -14.1 11.7 -13.6 28.9
1988 -7.2 - .9 -2.3 .4 -11.4 8.6 -4.3 20.0
1989 -3.8 7.1 7.0 5.4 7.7 -8.0 6.4 15.7
1990P -1.5 -14.6 -14.0 -12.7 5.0 8.9 -9.6 23.5
1991T -1.8 3.7 2.7 3.6 -7.2 - .9 .8 10.9
1992 5.5 - 6.3 - 6.0 - .7 -5.8 - .1 -3.6 11.8
1993 6.8 7.1 5.9 27.7 -12.4 -15.0 7.6 42.7
1994 5.9 - 2.1 - 2.0 2.4 - 8.0 2.0 -2.0 13.9
1995 .4 -10.1 -11.7 1.1 - 8.0 3.0 -7.8 14.7
(8)n. The highest percentage change minus the lowest percentage change for the six industrialized countries in columns (1) through (6).
P identifies a year containing a recessionary peak in US real GDP.
T identifies a year containing a recessionary trough in US real GDP.
Source of basic data: Economic Report of the President.
Year United Germany Japan United Interest
States Kingdom Spread
(1) (2) (3) (4) (5)n
1983 5.9( 3.7) 1.2( .7) 1.9( 3.1) 1.9( 3.7) 4.7
1984 6.1( 9.3) 2.5( 2.9) 1.3( 9.2) 1.4( .1) 4.8
1985 4.4( 1.7) 2.3( 4.5) 1.4( 3.6) 2.9( 5.5) 3.0
1986 4.6( 1.0) 3.9( 1.9) 1.2(- .2) 3.5( 2.4) 3.4
1987 3.3( 4.9) 3.0( .4) 1.7( 3.5) 1.2( 4.0) 2.1
1988 3.6( 4.4) 2.0( 3.9) 1.1( 9.3) 3.6( 4.8) 2.5
1989 4.3( 1.5) 2.8( 4.7) - .3( 6.0) 3.6( 2.1) 4.6
1990 2.8( .0) 4.4( 4.9) .5( 4.7) 2.7(- .3) 3.9
1991 1.6(-1.8) 4.1( 2.9) .6( 1.9) 4.2(-3.9) 3.6
1992 .7( 2.3) 4.0(-1.2) 1.1(-5.8) 3.6(- .5) 3.3
1993 .2( 4.2) 2.2(-7.8) .4(-3.5) 2.2( 2.5) 2.0
1994 2.0( 5.9) 1.8( 3.2) 1.0( 1.2) 1.0( 5.1) 1.0
1995 3.1 2.1 .9 .5 2.6
The inflation adjusted return on bank deposits is obtained by subtracting the year-to-year growth rate for the consumer price index from the average deposit rate. The figures in parentheses are the year-to-year growth rates for industrial production.
(5)n. The inflation adjusted interest rate spread is obtained by subtracting the lowest rate for any of the four countries from the highest rate.
Source of basic data: The growth rates for consumer price inflation and industrial production are from the Economic Report of the President. The average bank deposit rates are from International Financial Statistics.
Go on to Essay 17:
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