Quick response to Brad Setser
The ever-well-informed Brad Setser, who knows more about this topic than just about anyone, has a lengthy critique of my China column over at his blog. I’m on a Manhattan street corner, just coming from the superb Grand Sichuan International (9th St., between 49th and 50th, get the potatoes with vinegar), and headed to an appointment, so this will be quick rather than detailed.
Mostly Brad has mischaracterized my argument. He writes that I [Tyler] believe that: "the value of the RMB has no impact on trade." I wrote: "But even if the numbers work out so that the flow of dollars to China diminishes [TC: of course this depends on the time frame], American consumers will pay higher prices and see fewer goods from China. Yuan revaluation is unlikely to benefit the United States, even if it does lower its trade deficit."
Brad has a great deal of useful information on the European experience. My view is not that China should stay put on all matters of economic policy (see today’s FT for an excellent article on the internal Chinese debate); rather my argument is that the U.S. won’t do a good job micro-managing Chinese reforms. He has said nothing to convince me, or even try to convince me, I am wrong on that fundamental point.
On most of the other points, we are not so far apart. Brad is a great writer and international economist, and I don’t think he needs to "see red," although I am aware there remain important residual differences between us.
In gross terms, I would put the broader point this way. The fundamental problem in the U.S., to the extent we have one, is our propensity to spend, especially given our long-run demographic position and our government’s fiscal irresponsibility. I don’t see how pressuring a more rapid change in one set of relative prices (namely U.S. vs. China), which are likely to change anyway, will cure that ailment in a significant way. And while the world economy is obviously vulnerable right now, if there is an explosion I expect it to come from a hitherto-unpredicted direction, rather than from a phenomenon — the possibility of a rapid plunge in the US dollar — which has been the topic of unrequited doomsaying for quite a few years now. Keep in mind that the same models which tell us revaluation is the way to go also predicted we would be in the toilet two or three years ago.
Addendum: Here is commentary from Brad DeLong. Here is Greg Mankiw.
A few more random thoughts after digestion of my meal: A key reason to be skeptical of yuan revaluation is that it tries to address a relative prices problem by shrinking the opportunity set facing the U.S. That is not obviously the right way to go. The point is not to claim that all elasticities are zero, but rather that a trade balance shift, through revaluation, really does require a loss of resources. What fact about the world would make that the best way to go?
Unlike Setser, I haven’t much been worried about "the short run" over the last three to five years. But those worried about the short run, and surely Brad S. falls into this category, should be especially fearful of the short-run J curve whammy on the trade balance. It is also the case that exchange rate pass-through is poorly understood, J curves have thwarted many a currency plan, and I have heard credible arguments that the nature of exchange rate pass-through is shifting as we debate. Make of those what you will, but a plan to set everything right by inferring a U.S. adjustment from European data is not, in my view, a convincing policy proposal, especially when it involves shrinking the U.S. choice set, not to mention U.S. politicians who are not especially strong on either diplomacy or execution.