Wednesday, March 15, 2017

A Policy Proposal for US Manufacturing, and the Economy: Don't Raise the Federal Funds Rate

Doug Irwin shared a nice article in the WSJ which makes a nice point that trade deficits, by themselves, don't imply that trade is unfair. It's a good article. Here is one part: 

The Trump team is correct in believing that sometimes trade imbalances reflect government tampering, though in the capital markets. Messrs. Gagnon and Bergsten found that countries who buy foreign currency to suppress the value of their own tend to have larger trade surpluses. 
In the past Chinese currency intervention and tight controls on capital inflows kept the yuan artificially cheap and its trade surpluses inflated. Brad Setser of the Council on Foreign Relations says Taiwan and South Korea have held down their currencies via currency intervention and by encouraging domestic investors to buy foreign assets and discouraging foreign investors from buying domestic assets.
These actions are legitimate cause for complaint. Yet finding an effective deterrent has eluded previous presidents and it’s not clear what Mr. Trump can do differently. Punishing China for manipulating its currency makes less sense now that China is trying to prop it up, rather than push it down as in the past.
Let me offer a solution, that happens to cure other, perhaps more serious problems with the economy. The Fed should simply not raise interest rates as it is doing. In fact, it should probably be cutting them. If it did, the dollar will fall, and this will help manufacturing and help the trade balance. It would help the US move back toward its long-run growth path, and help inflation move up to its ostensible target. Unemployment is now low, and while it isn't crazy to think the Fed should raise interest rates, the Fed should transition to a 3% (or 4%) inflation target to make future zero lower bound episodes more unlikely, and they should treat that target symmetrically. This is a simple pro-trade and pro-manufacturing policy that will anger almost no one and actually be good for the rest of the world economy, as it will spur faster growth. Manufacturing employment will grow on two counts -- one from faster growth, and a second from a weaker dollar. This is the obvious play to help manufacturing, and what I pushed for when I worked in the Obama administration.

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