Feb 19 2008

Weak dollar to the rescue – how exports may save the US economy

Defining the macroeconomic problem – Paul Krugman – Op-Ed Columnist – New York Times Blog

Paul Krugman, economics columnist for the NYT, shares his views the true problem with the US macroeconomy. Krugman thinks that the source of instability today is too much consumer spending and too few exports in the last decade.

Basically, I’d say, the problem is twofold. First, in the mid-00s the U.S. economy got badly unbalanced — too much dependence on housing and housing-inflated consumer spending, too big a trade deficit.

The table here (from Krugman’s piece) shows the net change in consumer spending, investment (non-residential or business investment, and residential investment) and net exports between 2007 and the average for the last 20 years of the last century. Clearly, American’s conumption has been abnormally high, its investment in houses slightly higher than usual, and its exports to theINSERT DESCRIPTION rest of the world remarkably low.

The growth in GDP over this period, unsurprisingly, has been mostly on the back of consumer spending. Krugman sees the US at a turning point today, when the bursting of the housing bubble, causing the loss of large amounts of wealth, thus a contraction in consumer spending, along with an increase in exports resulting from the weakening of the US dollar, will combine to “rebalance” the US economy:

What we want, and will eventually get, is a rebalancing: smaller trade deficits, consumer spending more in line with income, more normal housing spending. The trouble is in getting there. At the moment it seems likely that consumption and housing investment will fall faster than net exports can rise — probably with additional downward pressure from at least some types of business investment, especially commercial real estate. The result will be a recession or at least something that feels like one

In the near future, Krugman foresees hard times for US households, but he argues that responsible monetary and fiscal policy should be able to “bridge the gap” between the consumption driven GDP of the last seven years and the balanced pattern of output to which he believes the country will return in the future, where consumption, investment, and net exports are more closely aligned with their historic averages.

Discussion questions:

  1. When measuring national income, does the type of spending matter? In other words, is America better off with high levels of consumption and low exports than it would be with lower levels of consumption and high exports?
  2. Why would a weaker dollar lead to an increase in exports from the US to the rest of the world?
  3. How can fiscal policy makers help “bridge the gap”, and try to avoid a catastrophic, recession inducing decline in investment while the economy adjusts to rises in net exports?

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

13 responses so far

13 Responses to “Weak dollar to the rescue – how exports may save the US economy”

  1. Mike Fladlienon 21 Feb 2008 at 12:14 pm

    consumption has historically been 67% of GDP…why does it suddenly matter now? i think the reason why the US has recessionary fears is simply because the fear a recession…if the Fed can do its job, there will be no recession and the weak dollar will not matter since NX are only 4.8% of GDP…i believe that consumers are pessimistic and so are businesses so they will cut back on spending…does this sound keynesian? i think it is and so does the government or they wouldn't be increasing their spending….

  2. kxc.024on 23 Feb 2008 at 10:12 pm

    A weaker dollar would increase exports from the States to other countries around the world because for them, imports of US products is now cheaper.

    I think that Krugman has a point: American consumers spend way more than they should or can afford. Although it's a stereotype to say that Chinese save more while Americans spend more, up to some extent it's true.

    Exporting will really help improve the US economy because it'll be included in the GDP (they really should import less as well). When measuring total income, I think that the type of spending does matter. If it's consumer spending, then it's the money of the people in the nation giving the money. But if it's exports, then it's people from other countries that help boost the GDP of the economy.

  3. Helenon 23 Feb 2008 at 11:06 pm

    In looking at the macroeconomy, too much reliance on consumer spending may be dangerous, as Krugman has described. But when we are looking at calculating GDP in absolutely mathematical terms, consumption (C) and net exports (X) contribute equally. It's not like one is weighted more heavily in GDP than the other, so when it comes down to the total GDP, I don't think it matters.

    The new, relatively lower value of the US dollar and the now relatively higher value of foreign currency allows foreign consumers to obtain more dollars with their own currency. It now takes them less of their own currency to buy US goods, which increases the overall demand for US exports.

    In "bridging the gap", the Federal Reserve should be cautious in lowering interest rates in its efforts to avoid recession. Too much reduction will cause even more consumption and investment, which in Krugman's opinion will just "widen" the gap. The government should avoid "retaliatory tariffs" that will hinder US exports by not imposing tariffs that are too high for foreign imports.

  4. Mollieon 24 Feb 2008 at 5:07 am

    No matter if the dollar switches from strong to weak or vice versa, people freak out; it all just depends on who it helps. A weak dollar will up the amount of exports, thus helping the economy, while it decreases the amount of concumer spending at home (which is bad in the short long, but will help to stabalize the economy on down the road). So the switch for the dollar causes panic now, but it will balance out (of course by then, everyone will have their own theories about how that happened [oh yes, the gov't pulled us out of that one in the nick of time]), and everyone will go back to their daily lives until it switches again and upsets the other group of people – everyone will never be happy at the same time, it's just a matter of who can scream the loudest when it's their turn to fall.

  5. judychenon 24 Feb 2008 at 6:51 pm

    I don’t think the type of spending matter since we look at the total Real GDP not the GDP from different types of Spending.

    A weaker dollar lead to an increase in exports from the US because the domestic goods costs relatively higher than US good (exports). Therefore, consumers tend to purchase cheaper goods, which are US goods.

    Fiscal policy makers help “bridge the gap” by decreasing the interest rate, so the price becomes lower which increases people’s purchasing power, leads to a higher GDP.

  6. andyxuon 24 Feb 2008 at 7:16 pm

    Obviously, the high domestic (consumer) spending has been a key to U.S. GDP growth for the past decades. It is so high that the net export factor is negative.

    Should the U.S. worry about this?

    No. First of all, the U.S. is still a major exporter of technology and services, the (larger) import component consists of oil, raw materials, and manufactured goods.

    Of course, if U.S. is really entering a recession, policymakers might want to weaken its dollar, especially against other currencies i.e. Chinese Yuan.

  7. kevinyehon 26 Feb 2008 at 12:33 am

    The weakening of the dollar has been talked about as a pretty BAD thing to most of the American people, yet here this guy is saying that the weakening of the dollar is actually going to HELP the US economy by stimulating net exports and increasing GDP. Honestly, the weakening of the dollar does result in harder times for domestic americans, but at the same time the huge imbalance of trade has led to a subtraction of GDP for a long time. Maybe it's time that they corrected this.

    Plus, the weak dollar will make the US similar to when China's RMB was weaker. THere is much more incentive for firms to invest in the US, also leading to increased GDP

  8. Margaret Liuon 26 Feb 2008 at 7:30 pm

    Personally, I think the US would be better with low consumption and high exports, only because the rest of the world would be a lot better off if the US consumed less. But economically, I think it's best if the US relies on something it can more directly control, its home economy than the economy of the world. Therefore, it'd be much more sound to consume more in the US and export less. It's also the US's comparative advantage to consume what other countries make and to provide them with our services in return.

    If the dollar weakened, US exports would be cheaper for other countries, causing the demand for them to rise. The currently weakening US dollar, may lead to this and increase the country's GDP.

  9. KatherineYangon 26 Feb 2008 at 8:14 pm

    Talking GDPwise, it doesn't really matter which is greater, consumption or exports. The weaker dollar will increase exports, which might not be a bad thing, I think American consumers consume too much as it is, but that's more environmentally speaking.

    With the weakened dollar, other countries can buy more of US goods with their currency, and demand rises.

  10. optional.xuon 26 Feb 2008 at 11:29 pm

    In terms of national income, it doesn't matter which section of the expenditures it comes from as long as its one of them.

    Exports will increase as in relativity, US goods will appear cheaper because the dollar isn't worth as much as the euro or other currency. Foreign firms will be more interested in buying from the US.

    Fiscal policy can fix a potential depression by lowering interest rates and allowing firms to keep investing in capital so it keep production costs low and efficient. Not only will a decrease in interest rates/tax rates allow companies to produce more to meet export demands, it will also allow consumers to spend more from their additional disposable income.

  11. emilyyehon 28 Feb 2008 at 8:46 pm

    This was actually one of the topics of my college essays! Too bad I had to write it before we actually studied macroeconomics. But this topic is really interesting in that there's so many places to analyze its impact. Besides the fact that it contributes to inflation, and is probably affecting recession fears in the US currently, there's the factor of US influence over other nations as a result of its previously stronger currency. However, as it continues to depreciate against most other currencies, its important to recognize that US influence may transfer over to the much stronger Euro or English pound.

    So it really depends on what the US is attempting to achieve in the coming years, whether it would like to continue improving its domestic economy, in which case stronger exports with the US dollar would certainly help, or whether it feels that it needs to continue holding its power worldwide.

  12. Claire Mon 29 Feb 2008 at 1:19 am

    I think the type of spending does not matter that much, whereas by how much extent the high levels of consumption and low exports is being circulated matters more.

    Why would a weaker dollar lead to an increase in exports from the US to the rest of the world?

    Because when the dollar purchasing power becomes weaker, the other countries buy more products from the U.S. due to the cheap price induced by the lower currency.

    By Fiscal policy interest rates are lowered and firms keep on invest which lead to the low cost.

  13. calebon 03 Mar 2008 at 10:23 am

    It would be great to think that if America could just increase their exports that the economy would be able to be saved. However Americans aren't keen on exporting because no one wants to do the grunt work of production. Today, people all think their too good to work blue collar so it doesn't matter what the wishes are of the masses or individuals, because no one is going to stand up and say, "i'll do the work." Therefore the U.S. is doomed for a very long time until people are forced to produce goods within the states.