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The laws of economics cannot be wished away

Summary:
In areas such as rent control and minimum wage laws there’s an increasing tendency to ignore the basic laws of economics, and hope they somehow don’t apply to the policy being considered. President Trump provided another example in this recent tweet: There are multiple errors here.  The first sentence is incorrect; the yuan was much lower when I first visited Beijing in 1994.  The second sentence is also incorrect, for two different reasons.  Currency manipulation is defined as artificially depreciating a currency to create a current account surplus.  China’s current account is roughly balanced, and the depreciation reflected market forces.  So there is no currency manipulation, no “major violation” of any agreement. One irony here is that it is President Trump’s

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In areas such as rent control and minimum wage laws there’s an increasing tendency to ignore the basic laws of economics, and hope they somehow don’t apply to the policy being considered.

President Trump provided another example in this recent tweet:

The laws of economics cannot be wished awayThere are multiple errors here.  The first sentence is incorrect; the yuan was much lower when I first visited Beijing in 1994.  The second sentence is also incorrect, for two different reasons.  Currency manipulation is defined as artificially depreciating a currency to create a current account surplus.  China’s current account is roughly balanced, and the depreciation reflected market forces.  So there is no currency manipulation, no “major violation” of any agreement.

One irony here is that it is President Trump’s policies that have caused the yuan to depreciate, as is explained in any principles of economics textbook.  When country A puts tariffs on the exports of country B, the currency of country A will appreciate and the currency of country B will depreciate.  This is ECON 101.

In a world with more that 2 countries, there will be additional effects.  China’s currency depreciation will push it to sell more goods to third parties, such as Europe.  That will cause depreciation of the euro—another issue that Trump has complained about.  Because the dollar would be expected to appreciate against almost all currencies, the US will buy more goods from third parties.

Textbooks also teach us that tariffs will not improve the trade balance, which depends on saving/investment imbalances.  Textbooks also tell us that a major fiscal stimulus will cause the trade deficit to get larger.  And that’s exactly what has happened, the trade deficits has become even “worse” over the past two years in response to Trump’s enormous fiscal deficits.

Trump’s reference to the Fed is an allusion to his earlier plea that the Fed manipulate the dollar lower.  It’s not clear why he would want the Fed to do that, as in the final sentence he says that currency manipulation will weaken China over time.  So why encourage the Fed to manipulate the dollar?  Wouldn’t that also weaken America over time?

Here’s King Canute:

The laws of economics cannot be wished away

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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