A strong dollar: Taking a deeper look

My previous post was rushed, and perhaps a bit tautological.  So let’s take a deeper look, and try to answer the comment left by Tyler:

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…?

Tyler probably wanted to make the dollar appreciation occur for no particular reason.  But of course he knew that there must be a reason, so he offered this:

For the relevant thought experiment, assume an exogenous shift in noise trading boosts the value of the dollar.

In simple supply and demand terms, that means the value of the dollar rises because noise traders suddenly increase their demand for dollars.  That’s what is commonly referred to as a “monetary shock”.  In this case, a contractionary shock. Recall that a contractionary monetary shock occurs when there is either a reduction in the monetary base (less supply), or an increase in base demand. Contractionary shocks also cause the dollar to appreciate.

Now here’s where things get complicated.  Tyler is clearly interested in real wealth, not nominal wealth.  But it’s not clear that a monetary shock will affect any real variable, either the real exchange rate or the level of real wealth.  Thus if money is neutral, then a contractionary monetary shock that appreciates the dollar by 4.3% will also cause all wages and goods prices and even stock prices to fall by 4.3%. This leaves the real wealth of Americans unchanged, they don’t even notice anything when they travel overseas.

Tyler would quite rightly respond that money is not neutral in the short run, and that a 4.3% nominal appreciation of the dollar would also imply a 4.3% real appreciation in the dollar, at least in the very short run before the price level had adjusted.  OK, so let’s go with that non-neutrality assumption, assuming sticky wages and prices.

But the problem with this assumption is that it really complicates the “ceteris paribus” problem.  If it’s really true that a contractionary monetary shock makes the real exchange rate appreciate, helping our tourists when they visit France, or buy French wine, it also, ipso facto, leads to higher real wages, which reduces employment and real GDP.  How does all this net out in terms of our welfare?  I don’t know.  To answer that question there is no shortcut to a plausible macro model that generates an optimal monetary policy for our domestic welfare.  In my view the “best” position for the US dollar in forex markets is the value it would hold if monetary policy was appropriate (say NGDPLT).  If NGDP is rising less than the target rate, then policy is too tight and the dollar is too strong, and vice versa

Tyler can change his assumption so that it’s no longer a monetary shock appreciating the dollar.  It could be a real shock (to S&I), which means the real value of the dollar appreciates even after sticky wages and prices have fully adjusted.  That might better fit the recent example of the US.  (But this is also confusing, because by this criterion the Swiss franc is very weak.  It would have to be much stronger to eliminate Switzerland’s huge current account surplus.)

I’m not as good at analyzing real shocks as nominal shocks, but my instincts tell me the answer will be “it depends.”

PS.  Ironically, Tom Powers just sent me this article:

Donald Trump is unsure if strong or weak US dollar is best for the economy



20 Responses to “A strong dollar: Taking a deeper look”

  1. Gravatar of Ray Lopez Ray Lopez
    8. February 2017 at 11:52

    Sumners: “My previous post was rushed”…it’s OK, we don’t take you seriously professor. We’re just here for fun.

  2. Gravatar of Jim Glass Jim Glass
    8. February 2017 at 14:21

    In just a few minutes I’ve already gotten three stories sent to me about Big D calling up General Flynn at 3am for exchange rate advice and not liking getting the answer, “I don’t know.”

    Here’s a good one Big D will enjoy as it muses about some broader implications…

    PR wise, President Clavin is off to a great start. This after lecturing all the Sheriffs yesterday about how the murder rate is at a 47-year high, but the press won’t report it. He’s getting better and better.

    But still, the truth should be enough, there’s no need to pile exaggerations on top. It just ruins the fun. From the story you linked to…

    “Since winning the most divisive election in US history last November…


  3. Gravatar of H_WASSHOI H_WASSHOI
    8. February 2017 at 14:35

    I read this post
    (memorial comment)

  4. Gravatar of Benjamin Cole Benjamin Cole
    8. February 2017 at 16:51

    Well, remember David Beckworth. The US can try for a strong dollar, but that will cause economic contraction around the globe, resulting in lower living standards for everybody.

  5. Gravatar of Ray Lopez Ray Lopez
    8. February 2017 at 16:56

    OT – read the below. Who is Sumner? No. No way. You think? No way. A mere coincidence they share the same last name. Not unlike the USA recovering, coincidentally, when confidence was regained after FDR’s fireside chats in 1933/34, by coincidence the same time the USA devalued the gold dollar. The opening paragraph from the book by Tracy Kidder, “A Truck Full of Money” – “The man on the stage in the jacket and tie, the headmaster, invited the new seventh graders to look at the names that graced the walls around them. Paul and his classmates, 350 boys and girls, turned their faces upward. A band of surnames, painted in large black letters, ran along the summits of the auditorium’s impossibly high walls. These, the headmaster said, were great Americans who had come before them here, at the oldest public school in America, Boston Latin. Paul recognized some of the names on the frieze. Franklin, that would be Benjamin, and John Hancock and Samuel Adams and Joseph Kennedy. Knowing those names was just part of growing up in Boston. Paul loved music and played the piano and was learning the trumpet, and he knew that Bernstein must be Leonard. Some of the others sounded familiar, such as Emerson, and Paul gathered that all the rest were part of history, too: Santayana, Mather, Sumner, Brooks, and twenty more. And, said the headmaster, the new students should take note: One space had been left open up there in that pantheon. Maybe one of them would fill it someday”

  6. Gravatar of Christian List Christian List
    9. February 2017 at 00:23

    Donald Trump is unsure if strong or weak US dollar is best for the economy.

    So Trump is basically saying the same thing as Scott about this topic. He is not sure, it depends. It’s just that Trump does not express this in such a sophisticated way. Or as Trump would say: “Beware, I know words.”

  7. Gravatar of Dan W. Dan W.
    9. February 2017 at 03:57

    Ray, it is fun. Good clean fun
    Christian, I had the same reaction about the headline you did. By golly, Trump is wrong if he thinks he can equivocate like an economist! Who does he think he is?

  8. Gravatar of dtoh dtoh
    9. February 2017 at 05:03

    I would look at it this way. If you are at the optimal level of employment/output (i.e. have a correct NGDPLT in your parlance), then any change in the exchange rate simply results in a marginal change in the exchange of assets for consumption goods. (Capital account up and current account down or vice versa). Since this is a voluntary exchange both parties are better off. Or to put it another way, you should be relatively indifferent at the margin to an fx move in either direction.

    This presupposes of course that the optimal mix of consumption and savings hasn’t been distorted with bad tax or supply side policies. If this is not the case and you have supply side policies which favor a sub-optimal level of excessive consumption, then generally speaking a higher dollar is a good thing because it indicates an increased inflow of capital, which leads to higher investment and a more optimal savings consumption mix.

    Just like with interest rates though you have to be careful of the ceteris paribus argument because while a stronger dollar will reduce capital inflows it is generally indicative of increased capital inflows….just as high interest rates are an indicator of an accomodative monetary policy.

  9. Gravatar of rayward rayward
    9. February 2017 at 06:42

    Of course, Cowen is a Sinophile (or is it Singaphile) and presumably would prefer policy that promotes China (and Singapore). My observation is that Cowen ignores the problems inherent in an economy dominated by the financial sector, a problem exacerbated in the US by a strong dollar; the strong dollar attracts investment in the dollar by plutocrats and other nefarious characters and governments, to the benefit of the financial sector but everyone else not so much. Better for the US to invest in other parts of the world than to depend on plutocrats and other nefarious characters and governments investing here. Everyone is confused. Or so it seems. https://www.nytimes.com/interactive/2017/02/07/business/china-bank-foreign-reserves.html?ref=business&_r=0

  10. Gravatar of ssumner ssumner
    9. February 2017 at 07:53

    Christian and Dan, You guys really are clueless. Trump is assuming there is a correct answer to his question, but he just doesn’t know what it is. This from a guy who’s been complaining that the Chinese yuan is undervalued!

    dtoh, You said:

    “Or to put it another way, you should be relatively indifferent at the margin to an fx move in either direction”

    That assumes you are still at the optimal level of NGDP afterwards (I think that is your assumption). You also need to consider why the exchange rate changes—it might be due to bad fiscal policies. But basically I agree, don’t focus on exchange rates, focus on the underlying policies. Exchange rates are not problems in and of themselves, they are symptoms of problems (jn some cases.)

    Rayward, Have no idea what you are rambling on about, but thanks for the comment.

  11. Gravatar of Thursday assorted links – Marginal REVOLUTION Thursday assorted links - Marginal REVOLUTION
    9. February 2017 at 09:42

    […] Scott Sumner on the stronger vs. weaker dollar.  I say imagine that foreigners decided to remit 1% of every dollar-connected foreign exchange […]

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. February 2017 at 09:59


    At the Trump Trauma Center, Nobody Comes for Treatment
    A sickness that makes sufferers feel terribly good about themselves.’

  13. Gravatar of Mike Rulle Mike Rulle
    9. February 2017 at 13:14

    “I don’t know if the price of Amazon Stock is too high or too low—“that’s because I actually think there is a right price—what a moron I am!

    Just because we don’t know the right price does not mean there is not a right price.

    And this from the same guy who thought that Apple was priced low at 15x earnings when it was growing at 40%-50% a year. Well it is low compared to Amazons 165 times earnings

    And Apple actually makes real CASH—

    We will know someday whether these prices were “too low or too high” just not today.

    So Trump actually thinks there is an answer___wow, what a dummy. Not like those other 44 presidents we had who knew there was no “answer”

  14. Gravatar of Saturos Saturos
    9. February 2017 at 15:20

    Not irony, that was the stimulus for Tyler’s post as well. The irony would be that this is getting passed around as an example of Trump having no idea about economics, but none of the economists he would be referred to would give him this sort of answer either.

  15. Gravatar of Saturos Saturos
    9. February 2017 at 15:22

    I mean there’s really only one solid piece of economic advice you can give Trump: quit your job.

  16. Gravatar of dtoh dtoh
    9. February 2017 at 15:22


    “That assumes you are still at the optimal level of NGDP afterwards (I think that is your assumption).”

    Yes… or that monetary offset will get you there.

    I didn’t go into this in my first comment, but this raises a couple of interesting issues/caveats.

    1. What is the optimal level for the NGDP target… especially with respect to not only a) inflation and real growth but also b) consumption and investment, and c) work and leisure. Is monetary neutral with respect to these trade offs or is there a bias that leads to a sub-optimal mix.

    2. From a theoretical point of view, depending on the shape of the marginal utility curves and where you are on those curves, it’s possible that an fx shift in one direction will get your more more utility than a move in the other direction

  17. Gravatar of TravisV TravisV
    9. February 2017 at 15:25

    Yglesias: “Is a strong dollar good or bad? An answer for Donald Trump.”


  18. Gravatar of Adovada Adovada
    10. February 2017 at 04:36

    I think the problem is looking at any of these economic variables as if they were a goal. In other words, the goal of society, or even economic policy is not to have a strong dollar, low inflation, a balanced budget, a neutral trade deficit, etc. The reason you can argue about any of those is they are not primary topics, but side effects of important policy. These (probably) desirable indicators would all be natural outcomes of policies with intelligent goals: effective and efficient education and health care, rational tax policy, pro-growth policies, more isolatiosist foreign policy, etc.

  19. Gravatar of ssumner ssumner
    10. February 2017 at 14:20

    Thanks Travis.

  20. Gravatar of Jim Glass Jim Glass
    12. February 2017 at 15:03

    Uh, oh, Flynn seems to be twisting in the wind. Multiple questions about “does the President still have faith in Flynn” were met with deafening silence on the political talk shows today.

    Supposedly it’s because of Flynn’s friendly past conversations with the Russians, now being checked by the FBI. But also, how many people are in on a 3am call from Trump, who can leak it to the press to make him look bad?

    And which do you really think would bother Donald the most?

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