Will Mitt Romney devalue the dollar?

July 18, 2012

There are a lot of interesting tidbits in this morning's op-ed by Glenn Hubbard, a Columbia economics professor and one of Mitt Romney's top advisers. James Pethoukis highlights Hubbard's endorsement of literature suggesting, against the view of most macroeconomists, that austerity is stimulative in the short-run. But what I found more interesting is the mechanism that Hubbard identifies as the cause of austerity's allegedly stimulative effect. Here's Hubbard:

This outcome reflects lower future tax rates and the boost from lower interest rates to investment and net exports.

And here's the Hoover Institution paper (pdf) by John Cogan, John Taylor, Volker Wieland and Maik Wolters that he cites:

Second, the expectation of reduced government spending in the future lowers interest rates, which stimulates demand today offsetting the decline in government spending in the short run.
And third, the lower interest rate reduces the exchange rate thereby increasing net exports which also offset the decline in government spending. More generally, the gradual and credible decline in government spending allows the private sector to adjust smoothly to the decline in spending without negative disruptions.

So the main mechanism by which this stimulus would happen is that interest rates on U.S. debt and the value of the dollar would fall. The interest rate decline would reduce the cost of loans in general, as many are pegged to the interest rate on debt, and the lower value of the dollar would make exporting cheaper, stimulating growth in that area.

First, it's worth noting that the interest rates on U.S. debt already are extremely low. As Ezra noted the other day, once you account for inflation, they're actually negative. For them to get lower, investors would have to be willing to pay the U.S. even more money for the privilege of buying their bonds. It is hard to see how austerity would accomplish this. It could perhaps hurt growth by enough that scared investors want to pay more to park their money in U.S. bonds, but in that case the overall effect isn't stimulative at all.

The Congressional Research Service, for one, is skeptical that fiscal consolidation has much of an effect either way on interest rates:

In the current state of the U.S. economy, with a sizable amount of economic slack and weaker than normal private demand for credit market funds, current government borrowing does not appear to have elevated market interest rates, and, therefore, does not appear likely to exert upward pressure on the exchange rate.

In other words: borrowing isn't raising interest rates, so cutting the deficit won't lower them.

Second, it's worth emphasizing that one of Romney's top advisers is promoting economic stimulus through a lower dollar. That could be good idea, as cheap dollars are generally helpful in economic slumps, but it's an interesting position for a Republican candidate to embrace. Paul Ryan has declared, "There is nothing more insidious that a country can do to its citizens than debase its currency," while Tim Pawlenty has said "When you devalue the dollar, you are devaluing the net value of this country." This sort of rhetoric could make it difficult for Romney to follow this path if elected.

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Suzy Khimm · July 18, 2012