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February 04, 2009

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Nick Rowe

Because it is not obvious that international coordination is needed. With flexible exchange rates, and static expectations of the exchange rate, a fiscal stimulus will not cause a fall in net exports. So the full effect of a fiscal stimulus is felt on domestic absorption.
http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/01/buy-domestic-policies-are-individually-irrational-too.html

Dani Rodrik

Nick Rowe's comment above assumes domestic fiscal expansion will depreciate the exchange rate, bringing net exports back to (original) balance. This is an interesting point, but I would worry that it places too much weight on the adjustment through the current as opposed to the capital account. Even if US interest rates were not to respond, there is a whole lot of people and institutions out there who would rather hold US government debt than whatever else they are holding right now. (I.e., they are no different than US residents in that respect.) So I think it is a safe bet that the equilibrium adjustment in the US current account will be less than complete--and some of the demand stimulus will leak out.

Nick Rowe

Thanks for the response!

That's an interesting way to look at the question.

Agreed. There is a very high global demand for government debt, especially US government debt. (And that is a very large symptom and cause of the problem.)

The question is, however, would the foreign demand for US debt increase in response to an expansionary fiscal policy? If 'yes', then a US fiscal expansion would cause a decline in US net exports, and you can make a case for international coordination. If 'no' then the capital account won't change, and so net exports won't change, so international coordination won't be needed.

I can't see any obvious reason why a US fiscal expansion would increase foreign demand for US debt. If anything, it might reduce foreign demand, if it were perceived to make US debt riskier, since there would be more debt outstanding. And then US net exports would actually rise, so you would get a crowding-in effect.

I don't know if you are right or if I am right. But what bothers me is that I don't see much analysis of this question anywhere. How fiscal policy affects the exchange rate and net exports, under current conditions, ought to be one of the things we are analysing.

Per Kurowski

There are though many domestic issues pending

I received a letter from one of those big banks that has recently received billions of dollars in official assistance, informing me that if I finance my purchases with my credit card, where I have ample credit available since I repay all my consumptions monthly, my interest rate will be 17% and, if I enter into any default, 26%. This all in a country where there are no inflation expectations; the government is paying zero rate on its short term borrowings and contemplates a close to a trillion dollar stimulus package; and everyone wants the consumers to spend more to get the economy from falling. For a consumer to finance the anticipation of any purchases with these interest rates would be an act of extreme irresponsibility.

Why would anyone stimulate the economy before making sure that all the new green sprouts are not going to be devoured by some of the players in the financial sector?

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I'm not against the adding of the Blinder to the list international coordination on fiscal stimulus. The advantages and the problems are described in excellent way by the previous commentators. I think it's a good idea!

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