August 10, 2008
Current Account Adjustment Redux? What's Different this Time Around
A month ago at a conference in Siena, Gian Maria Milesi-Ferretti outlined the similarities and differences between the two episodes cogently (while the presentation is not online, but some of the points are recapped in this speech by IMF DMD Lipsky, here). He summarized the changes in various macro aggregate in the upswing and the downswing of the dollar in the two episodes in two sets of figures.
A comparison with the 1980's: The dollar appreciation period
A comparison with the 1980's: The dollar depreciation period
Milesi-Ferretti highlights the differences:
Adjustment in the 1980s
- Helped by oil prices
- Large transfers in 1991 associated with first Gulf war
Current Adjustment Episode
- Oil prices hindered adjustment
- Further $ depreciation effects "in the pipeline"
One big difference is that in the 1980's the oil component of the US trade balance worked with current account depreciation to shrink the deficit. This time around, it's worked in a direction counter to the adjustment.
One is tempted to say the recent decline of oil prices off it's highs will reverse this effect. In rebuttal, I'd say it's got a long way to go down to fully reverse this effect, and replicate the 1980's experience.
Milesi-Ferretti stresses the fact that analyses that omit the impact of oil prices (and the terms of trade) on the equilibrium real exchange rate of the dollar will likely mis-estimate the extent of dollar misalignment.
I would highlight another big difference between what I'll call the CA Adjustment of Bush the Elder, and the CA Adjustment of Bush the Younger: fiscal consolidation, or lack thereof. For the FY1987-91 period, the cyclically adjusted standardized budget balance improved by 0.8 ppts of potential GDP; for the 2004-08 period, the cyclically adjusted standardized budget balance improved by 0.3 ppts over the FY2004-08 period (Source: CBO, Jan 2008) (I'm assuming the stimulus package increased the deficit by 1 ppt of potential GDP above the FY2007 standardized budget balance).
Some will be tempted to say that 0.3 is not much more than 0.8 ppts. I'll observe that if the estimate of potential GDP is revised downward from that reported in the January 2008 CBO report, then the fiscal consolidation this round will be even smaller. Second, the long term budget outlook is considerably different now (as opposed to 1991), with incipient Medicare costs burgeoning.
I wonder if oil prices would have jumped so much without the consumption binge driven by the fiscal profligacy of the past seven years, financial regulatory disarmament, and the housing boom. Some of these factors are being unwound now; but the implications of fiscal decisions made since 2001 remain . Truly, I think Clive Crook has it right -- the Bush Administration engaged in "outrageous fiscal excess" that we will paying for for decades.
So, I'd say without further dollar depreciation -- most likely against currencies besides the euro -- and some fiscal retrenchment, we won't be seeing an exact replay. (For a cautionary tale, see Bertaut et al. (2008).)
Posted by Menzie Chinn at August 10, 2008 10:00 PMdigg this | reddit
Professor Chinn, both you and Clive Crook may be correct that the Bush administration engaged in "outrageous fiscal excess", but is there more rigorous evidence for this claim and the notion that fiscal excess has driven our current account deficit?
I myself can think of about 30 possible drivers of current account imbalances. For example, how would we know that fiscal excess is a greater driver than private saving and investment decisions? Thanks.
Posted by: Charlie Stromeyer Jr at August 12, 2008 06:08 AM
Posted by: Menzie Chinn at August 12, 2008 08:25 AM
Reading Bertaut's paper made me write a rant, but I decided not to post it here because it's not relevant to the subject. If you want to hear about Bertaut, income balance deficit and why I'm bearish on the US, see the latest post on my blog
Posted by: RK at August 12, 2008 09:37 AM
Balderdash! (how's that for a reply?!?)
This post is nothing more than confirmation bias and Bush Derangement Syndrome.
You're telling me that the runnup from, let's say, $80 a barrel to $145, or the runnup in the Euro from, say, $1.20 to $1.60, was from Bush's "outrageous fiscal excesses"?
If so, why on earth did oil only exceed $80 a barrel in very late '07? Ditto for the Euro.
And why have they backed off those peaks in the last few weeks?
The timeline does not in any way jibe with your explanation.
And why are so many people forcasting an increase in dollar strength moving forward? If anything, we haven't seen anything with regards to the federal government's fiscal excesses.
Based on the last week, I think that dollar strength and oil prices are a completely random phenomenon. You want to predict the oil price? Do a Monte Carlo analysis!
Posted by: Buzzcut at August 12, 2008 10:29 AM
Buzzcut: I didn't say the entire increase in oil prices was due to fiscal excess. All I need is that tax cuts and spending increases pushed up US aggregate demand above and beyond what they otherwise would have been; housing and consumption booms (recall I mentioned financial regulatory disarmament) could account for another component. These would be added to the demand attributable to China, which I freely admit is not directly in the control of US policymakers.
If you've been reading the financial press, dollar strength is in large part due to anticipated macro weakening in Europe.
I think reasonable people can disagree. But I find your last point -- dollar strength and oil prices are a completely random phenomenon -- remarkably nihilistic for a person who has in the past forwarded structuralist interpretations for other macro trends and events.
Posted by: Menzie Chinn at August 12, 2008 10:56 AM
I was surprised to see the comparatively low real exchange rate depreciation for 2004-8. I had thought it was more.
Presumably, when you say:
"So, I'd say without further dollar depreciation -- most likely against currencies besides the euro -- and some fiscal retrenchment, we won't be seeing an exact replay."
You are talking of Asian currencies.
Posted by: Alice Cook at August 12, 2008 11:30 AM
But I find your last point -- dollar strength and oil prices are a completely random phenomenon -- remarkably nihilistic for a person who has in the past forwarded structuralist interpretations for other macro trends and events.
Yeah, it's a recent conversion. The extremity of the oil rise, and now fall, for seemingly no reason whatsoever, has been quite convincing.
I understand your point, I just think a bubble created by US fiscal excesses doesn't explain the recent runnup in oil prices for no other reason than the timing is not right. If oil peaked in '06, I'd be with you.
Posted by: Buzzcut at August 12, 2008 01:49 PM
These would be added to the demand attributable to China, which I freely admit is directly in the control of US policymakers.
You mean "directly in control of oil prices", right? Or "not in control of US policymakers". Or something.
I think that these external factors (rapidly industrializing countries like China and India, mercantile trade policies by China, Japan, Korea, etc.) explain a hell of a lot more than anything US fiscal and monetary policymakers do.
Posted by: Buzzcut at August 12, 2008 01:59 PM
Buzzcut: Thanks for catching the typo. Fixed now.
Posted by: Menzie Chinn at August 12, 2008 02:14 PM
It's hard not to blame the foreign and fiscal policies for the rise in the price of oil and inflation in general. It is now generally acknowledged that the invasion was about securing the supply of oil to the West and coincidentally reestablishing control of the trade to multinational oil firms. So far the economics have not proven favourable for the US taxpayer and consequently the USD. Estimates vary from a low of 500 billion to somewhere over 1 trillion dollars of future American GDP (the cost has been borrowed) have been exported to the middle east and blown up. One of the consequences of these skyrocketing unfunded expenditures has been price inflation.
When Bush invaded Iraq in 2003, the price of oil was $27 a barrel, $31 adjusted for inflation in 2007 terms. The inflation adjusted price rose another $10 in 2004 to $42., another $12 in 2005, $7 in 2006, and $4 in 2007 to $65 a barrel. But in the last few months the price has more than doubled to bout $145 and more recently retreated to 115.00. It is difficult to explain a $100 jump in price in terms other than speculation. During the Bush regime, the price of oil moved from $27 to $145.
The other side of the coin has of course been the refusal to pay for the war and other expenditures by raising taxes. The quaint neo-con notion that government can spend limitlessly and can cut taxes simultaneously with no negative fiscal consequences has been shown by events to be the balderdash that it has always appeared.
disclaimer: I am a fiscal conservative who believes fervently in the wisdom of a balanced budget. I must have Bush Derangement Syndrome.
Posted by: Broxburnboy at August 18, 2008 06:48 PM