The elephant in the corner
I got the conference volume from the Reserve Bank of Australia 2005 Conference quite a while ago, but I’ve only just read them. The main focus is on the decline in the volatility of the business cycle observed in the English-speaking countries since the mid-80s (or in Australia’s case since the end of the last recession).
There’s a lot of discussion of monetary policy, micro reform and so on, but no mention of what I would see as the single most important factor – the abandonment of the external balance objective. For most of the postwar period, economic policy makers juggled the desire to keep the domestic economy stable with the constraint imposed by the balance of payments. Not surprisingly, this was a difficult job and promising economic expansions were regularly choked off because of emerging current account deficits.
Now we have a deficit of 7 per cent of GDP (as do most other English-speaking countries) and no one worries. The assumption is that borrowers and lenders are consenting adults who can make their own decisions. Right or wrong, this assumption makes macroeconomic management an awful lot easier.
We may well be about to find out whether policymakers have been right to view trade deficits with benign neglect. The US dollar seems to be beginning its long-awaited depreciation against the euro and other trading partners (even against the $A) and long-term interest rates are rising. Some combination of the two should sooner or later bring the US back into trade balance. The question is whether this adjustment will be smooth or painful.