As the economy slows the Fed usually acts to lower interest rates to boost the economy. The NYT says that this is what the Fed should be doing now, except that it can't because if the Fed lowered interest rates, the dollar might fall. The editorial then blames the Bush tax cuts for this problem. Okay, Econ 101 time. One of the main ways in which lowering interest rates is supposed to affect demand and stimulate the economy is by lowering the dollar and improving our trade balance. A lower dollar makes imports more expensive to people in the U.S., thereby encouraging people to buy domestically produced goods. It also makes our exports cheaper for people living in other countries, thereby encouraging exports. The link between interest rates and the dollar can't be blamed on Bush's tax cuts, it is basic economics. In fact, we all should want a lower dollar, unless we think that the country should have a trade deficit equal to 5 percent of GDP forever (which of course we can't). As an alternative to the falling dollar, the NYT proposes that we can correct the trade deficit by increasing savings, especially by taking back the tax cuts. (Actually, the main reason that savings are despressed in the U.S. is the housing bubble, which has boosted consumption. The impact of the tax cuts is much smaller.) But, the NYT is right that higher savings can reduce the trade deficit. There are two routes through which higher savings can reduce the deficit. Other things equal, higher savings slow the economy. (If we have less consumption, and no offsetting increase in other demand, then we have a weaker economy.) When the economy weakens, we buy less of everything, including fewer imports. In other words, if we throw the economy into a severe recession, we can move towards balanced trade. Is the NYT advocating a severe recession to cure the trade deficit? It seems that they are, because the other mechanism through which increased saving can be expected to reduce the trade deficit is by (drum roll please ........) yes, A LOWER DOLLAR! Of course the surging trade deficit predated Bush and the tax cuts. The trade deficit went from just 1.2 percent of GDP in 1996 to 3.9 percent of GDP in 2000. You remember 2000, that was the year when we had a budget surplus of more than $200 billion, about 2.4 percent of GDP. It's a bit hard to blame the huge 2000 trade deficit on a budget deficit in the real world. The bottom line here is that the U.S. (under Clinton and Rubin) had a high dollar policy. They said it was a good thing to have a high dollar -- it keeps inflation low. Of course, in the short-term, a high dollar is good. Just like a tax cut, it can allow people to enjoy higher living standards by consuming goods that they are not paying for. But, in the long-run, the trade deficits from an over-valued dollar are no more sustainable than tax cuts that lead to bloated budget deficits. The dollar is at risk of falling -- in fact must fall -- because Rubin and Clinton allowed it to rise to an unsustainable level. It's that simple. There are plenty of good reasons for criticizing Bush's economic policies and especially his tax cuts for the wealthy. But Bush can't be blamed for basic economic relationships. The trade deficit can only realistically be addressed by a falling dollar. We cannot blame President Bush for this fact.
--Dean Baker
