Mensch tracht, und Gott lacht

Friday, December 03, 2004

Some Holiday Cheer

Happy Chanukah next week, my fellow proletarians. While many of the policy geniuses in Washington view the ever-weakening dollar as the joyous payoff to a winning spin of the dreidel--- export sectors generally and manufacturing in particular will boom!---the reality is that a weakening dollar is bearish for the economy in the aggregate. Exports will increase and imports will be come more expensive and thus will decline; and so the aggregate pie will become smaller. In short, the economy will be poorer because of the weakening dollar, and this will show up as a "one-time" increase in the aggregate price level.

That is not the same as an increase in the rate of inflation, although the two are difficult to distinguish because of the way that we are forced to measure aggregate prices changes. (An increase in inflation is an increase in the
rate at which prices rise over time; a weakening dollar, again, yields a one-time aggregate price jump.) And so the Beltway geniuses really ought to abandon their infinite myopia and consider what the Fed might do when confronted next year with what will appear to be rising inflation: They will have incentives to tighten, as their job is to achieve price stability. This will be the incorrect policy prescription, as the sources of a weakened dollar cannot be reversed by slowing the printing press (although higher interest rates as an ancillary effect will increase the demand for dollar-denominated assets, thus perhaps propping the dollar up). Will this negate the increasing unwillingness in Asia to hold dollars? That is doubtful; and so next year offers the possibility of a weak dollar, higher prices in the aggregate, and an economic slowdown due to Fed reactions. This may not happen, but it is hardly implausible. What is implausible is the prospect that conventional Beltway wisdom actually will recognize this scenario as serious, in that much Washington commentary follows the herd as it applauds a weak dollar as a source of "jobs," or some such nonsense. That the Administration seems not to be immune to this way of thinking is a good reason to drown our sorrows. And I am not talking about egg nog.

1 comment:

Glaivester said...

I was under the impression that inflation actually refers to the rate at which the money supply is increased; rising prices are actually a result of inflation.