Is a strong dollar good?

Here’s Tyler Cowen:

Is a strong dollar better than a weak dollar?

Yes, for Americans though not for the world as a whole.  For the relevant thought experiment, assume an exogenous shift in noise trading boosts the value of the dollar.  That increases the wealth of individuals and institutions that are long dollars, and presumably this is the case for this country overall.  If you owned lots of ponies, would you not want the price of ponies to go up?

A weak desire to substitute into imports could blunt this result somewhat.  Or in other words, American tourists will benefit to a disproportionate degree.

I can imagine three scenarios:

A.  The dollar is currently below its optimal value for maximizing the welfare of Americans.

B.  The dollar is equal to its optimal value for maximizing the welfare of Americans.

C.  The dollar is above its optimal value for maximizing the welfare of Americans.

In case A, dollar appreciation makes Americans better off.

In case B and C, dollar appreciation makes Americans worse off.

The probability of case B is roughly 0%. So without knowing anything more I’d say there is a 50-50 chance of Tyler being right. His chance of being right is more than 50% if we can clearly establish the case for some sort of market or policy failure that results in the dollar usually being too weak for optimal welfare.  That’s possible, but it’s not obvious to me exactly what that distortion is.  And if true, it would suggest that “reverse beggar-thy-neighbor” policies might be optimal.

PS.  His noise trading assumption can be viewed as an exogenous increase in dollar demand, not motivated by fundamentals.  One can imagine other ways of getting a stronger dollar, such as a random drop in national saving.  His assumption seems aimed at getting a move in the dollar with the smallest deviation from the “other things equal” assumption.  I think his approach is plausible, and hence I do not object to the thought experiment on “reason from a price change” grounds.

Update:  It just occurred to me that my analysis only applies to tiny changes in the value of the dollar.  For large changes, random moves will push it in the wrong direction more than 50% of the time.


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8 Responses to “Is a strong dollar good?”

  1. Gravatar of H_WASSHOI H_WASSHOI
    8. February 2017 at 08:44

    If the free market determines the exchange rate, the probability of B is 100%.

    No?

  2. Gravatar of Tyler Cowen Tyler Cowen
    8. February 2017 at 10:25

    One shift increases national wealth, however, and the other lowers it, so why is that not a strong presumption in the direction of my answer…?

  3. Gravatar of H_WASSHOI H_WASSHOI
    8. February 2017 at 10:30

    The forex market participants can long&short.
    I see simple(low level) noise trader(participants) effect is little.

    > an exogenous increase in dollar demand, not motivated by fundamentals.

    If some distortion shift the rate high or low to inefficient economy,
    I think the economists should directly talk about the distortions.

    AM 3

  4. Gravatar of H_WASSHOI H_WASSHOI
    8. February 2017 at 11:22

    US people live in US.
    Their future’s liability is also US dollar.
    Import/GDP is relatively low.

    Need higher exchange rate from the efficient equilibrium?

  5. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    8. February 2017 at 11:25

    Charles Calomiris has a new paper with (as usual) much food for thought;

    https://object.cato.org/sites/cato.org/files/serials/files/cato-journal/2017/2/cj-v37n1-1.pdf

    ———-quote——–
    At a recent conference, I reviewed the adverse consequences of
    Fed policies for bank equity values and repo funding costs and
    argued that the loan-supply consequences of Fed policy have been
    contractionary. I was expecting a vigorous disagreement from the
    representatives of the mainstream point of view, but instead a former high-ranking Federal Reserve Board economist responded that the Fed’s internal model of the transmission mechanism of monetary
    policy agreed with my conclusion. The Federal Reserve Board
    model, according to him, implies that monetary policy currently is
    having a contractionary effect on loan supply. But, he said, according to the Fed’s model, that contractionary effect is more than outweighed by other effects, especially an expansionary effect operating through exchange rate depreciation.

    I was stunned. How could the Fed believe that its attempt to
    depreciate the dollar would work, especially at a time when so many
    other countries (most obviously, members of the eurozone and
    Japan) are struggling to restore growth? Indeed, according to IMF
    research, augmented in Taylor (2016), Fed decisions to lower interest rates have negative effects on economic performance outside the United States—presumably, by disadvantaging foreign exporters.

    Furthermore, if depreciation is harmful to foreign countries, then
    wouldn’t other central banks respond to Fed actions by intervening
    to offset the Fed’s actions? If so, then the ultimate consequence for exchange rates of Fed policy might be nil. Finally, isn’t this a risky strategy for the U.S. central bank? The desirability of avoiding the risks that attend unpredictable depreciation wars among central banks was supposedly a major lesson of the 1930s and a major
    reason the IMF was established. How can the Fed defend a policy
    that will likely be ineffectual (because it will be largely offset by other central banks) and likely will produce a new source of international conflict with the U.S.’s major trading partners?
    ———-endquote———

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    8. February 2017 at 11:38

    Regarding Calomiris mention (above) of repo funding costs, I was unaware of this;

    ————quote———–
    It is important to recognize that the Fed’s new role as a repo counterparty (since 2013) does not offset the collateral drain produced by the Fed’s accumulation of repo collateral on its balance sheet. The Fed lends its collateral into the market in exchange for cash. Because the Fed engages in triparty transactions, the repo collateral employed in Fed transactions cannot be re-hypothecated in other transactions.

    On net, Fed “reverse repos” drain cash from the market and do not
    provide collateral that can be used by other repo market participants. The Fed’s dual role as a regulator and a repo counterparty also raises important new and disturbing questions about a new conflict of interest. As a repo counterparty, the Fed benefits financially from its imposition of the SLR [supplementary leverage ratio], which reduces its competitors’ abilities to engage in similar transactions. Is it conceivable that the Fed might have taken into account its own financial benefits from being able to engage in reverse repo on more favorable terms when setting regulations for its competitors? Yes, it is. When the Fed began contemplating its reverse repo tool, it was already cognizant that it might want to engage in a large amount of such transactions. The Fed was concerned that if it failed to raise sufficient revenue from lending securities in the repo market, its expected accounting contribution to federal deficits would rise.

    As many observers noted, the likely financial costs to the Fed from experiencing losses in the future has potentially important adverse political implications for the Fed. Indeed, one of the reasons the Fed planned to engage in massive amounts of repo, rather than selling securities into the market, was political. Employing repos rather than selling securities allows the Fed to avoid the expected accounting consequences of recognizing capital losses from securities sales, which (under current Fed accounting rules) would increase its measured contribution to government deficits. I do not claim to know that the Fed’s SLR was motivated in part by a desire to improve its competitive position in the repo market, but the coincidence in timing between the SLR and the Fed’s entry into the repo market is disturbing, and there is no question that the Fed suffers a conflict of interest from being both a repo counterparty
    and a regulator. That conflict adds to the preexisting list of conflicts that would be resolved by removing the Fed from its role in setting regulatory standards.
    ————endquote————

  7. Gravatar of ssumner ssumner
    8. February 2017 at 13:10

    Wasshoi, The Fed also plays a role in determining exchange rates.

    Patrick, You quote Calomiris as saying:

    “The desirability of avoiding the risks that attend unpredictable depreciation wars among central banks was supposedly a major lesson of the 1930s and a major
    reason the IMF was established.”

    But we now know that those depreciation wars were helpful to recovery.

  8. Gravatar of H_WASSHOI H_WASSHOI
    8. February 2017 at 14:34

    oh.yes. FED is one of resource of distortion. not free banking

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