Domestic inflation reflects domestic monetary policy.
To finance this trade deficit, the U.S. has to borrow from the rest of the world or sell American assets like stocks, businesses, and real estate to the rest of the world.
Increased government spending can provide a temporary stimulus to demand and output but in the longer run higher levels of government spending crowd out private investment or require higher taxes that weaken growth by reducing incentives to save, invest, innovate, and work.
A second reason why science cannot replace judgement is the behavior of financial markets.
The only way that we can reduce our financial dependence on the inflow of funds from the rest of the world is to reduce our trade deficit.
So just as I want pilots on the planes that I fly, when it comes to monetary policy, I want to think that there is someone with sound judgement at the controls.
Thirty years ago, many economists argued that inflation was a kind of minor inconvenience and that the cost of reducing inflation was too high a price to pay. No one would make those arguments today.
The good news is that a competitive dollar in the global market and a strong dollar at home are compatible in both the long run and during the transition to a more competitive dollar.
And finally, no matter how good the science gets, there are problems that inevitably depend on judgement, on art, on a feel for financial markets.
But then in April of 1985 the dollar began a sharp decline. The dollar's trade weighted value fell 23 percent in just 12 months and by a total of 37 percent by the beginning of 1988.
Inflation is lower and more stable and the real business cycle fluctuations are more modest.
Although economists have studied the sensitivity of import and export volumes to changes in the exchange rate, there is still much uncertainty about just how much the dollar must change to bring about any given reduction in our trade deficit.
A rise in the level of saving can reduce aggregate activity temporarily but only a sustained high level of saving makes it possible to have the sustained high level of business investment that contributes to the long-run growth of output.
We are particularly poor at the open economy issues.
Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumer durables, home improvements and the like.
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