Thanks jean.

http://gregmankiw.blogspot.com/2009/12/smoot-hawley-revisited.html

In other posts I have discussed a general problem with the “ceteris paribus” assumptions in all these policy counterfactuals. If monetary policy is doing its job, and targeting AD to grow at the desired rate, then no policy that has negative efficiency effects can help the economy, for the simple reason that it won’t boost expected AD, and it will worsen AS. This applies to both fiscal stimulus and protectionism. So any sort of second best policy like fiscal stimulus or protectionism requires some sort of assumption about inefficient monetary policy, so that the second best policy somehow makes NGDP rise. That is of course possible, especially if you are in a liquidity trap. But it is also far from certain, even in a liquidity trap. In that case one looks for real world evidence. Obviously SH didn’t work, and your surplus country explanation is plausible. But that is why I’d like to know more about the earlier examples. I recall the previous tariff was under Harding. And of course the economy did well under Harding. But that raises the issue of ceteris paribus. Harding also had very pro growth policies like big tax cuts and effective monetary policy after the steep deflation he inherited from Wilson.

My own view is that it is dangerous to adopt policies that one knows are bad from an AS perspective, on the hope that it will be a backdoor way of getting NGDP higher, i.e. a way of circumventing monetary policy. The Fed clearly is looking at variables like real growth and inflation when deciding when to adopt its exit strategy, so Krugman’s assumption that we can hold Fed policy fixed in any counterfactual is very dubious. I’d rather hold NGDP fixed, and think about the policy’s impact on RGDP under those circumstances.

Pacer, I think you are mixing up velocity and trade flows, which are two unrelated issues. Also, trade surpluses don’t mean a country is saving and investing a lot. I believe that both values have fallen sharply in Japan, it just means saving is greater than investment.

Then there is the effect of credit. When China runs a trade surplus, it invests that surplus in hard infrastructure and additional production capacity–each of which tend to lower the cost of goods (i.e. deflation). Latin American trade surpluses are more likely to be consumed in the form of end-user commodities and finished goods, which is inflationary.

Of course, the trends today aren’t sustainable. The U.S. has moved forward so much consumption–through borrowing–and neglected investment in future productivity, that it’s a gravy train with limited tracks. Perhaps this ends in a bailout of the U.S. and a reversal of fortunes that will eventually lead to a more investment/savings-oriented U.S. subsidizing consumption in other countries. Won’t be such a nice time for Americans, but in today’s interconnected world there just doesn’t seem to be any way around generational warfare…

I know I am coming in late, but I have to agree with what I think OGT is saying. It seems to me that the impact of trade contraction depends to at least some extent on whether a country is running a large trade surplus or deficit. One of the reasons Hoover had difficulty vetoing SH was because in the past raising tariffs seemed to have been expansionary, so it seemed a logical policy in 1930 to deal with the contraction in global demand. I would argue however that because before WW1 the US mostly ran trade deficits, and sometimes very large ones, the impact of trade contraction provided at least a short term increase in net domestic demand.

Once it began running large trade surpluses, however, the same strategy would have the opposite impact since with a contraction in trade the excess of domestic production over domestic consumption had to be reconciled domestically without recourse to foreign net demand. In other words SH was a bad idea for surplus countries in both the long and short term if it invited retaliation, but not necessarily bad for deficit countries in the short term.