A month ago at a conference in Siena, Gian Maria Milesi-Ferretti outlined the similarities and differences between the two episodes cogently (while the presentation is not online, but some of the points are recapped in this speech by IMF DMD Lipsky, here). He summarized the changes in various macro aggregate in the upswing and the downswing of the dollar in the two episodes in two sets of figures.
A comparison with the 1980′s: The dollar appreciation period
A comparison with the 1980′s: The dollar depreciation period
Milesi-Ferretti highlights the differences:
Adjustment in the 1980s
- Helped by oil prices
- Large transfers in 1991 associated with first Gulf war
Current Adjustment Episode
- Oil prices hindered adjustment
- Further $ depreciation effects “in the pipeline”
One big difference is that in the 1980′s the oil component of the US trade balance worked with current account depreciation to shrink the deficit. This time around, it’s worked in a direction counter to the adjustment.
One is tempted to say the recent decline of oil prices off it’s highs will reverse this effect. In rebuttal, I’d say it’s got a long way to go down to fully reverse this effect, and replicate the 1980′s experience.
Milesi-Ferretti stresses the fact that analyses that omit the impact of oil prices (and the terms of trade) on the equilibrium real exchange rate of the dollar will likely mis-estimate the extent of dollar misalignment.
I would highlight another big difference between what I’ll call the CA Adjustment of Bush the Elder, and the CA Adjustment of Bush the Younger: fiscal consolidation, or lack thereof. For the FY1987-91 period, the cyclically adjusted standardized budget balance improved by 0.8 ppts of potential GDP; for the 2004-08 period, the cyclically adjusted standardized budget balance improved by 0.3 ppts over the FY2004-08 period (Source: CBO, Jan 2008) (I’m assuming the stimulus package increased the deficit by 1 ppt of potential GDP above the FY2007 standardized budget balance).
Some will be tempted to say that 0.3 is not much more than 0.8 ppts. I’ll observe that if the estimate of potential GDP is revised downward from that reported in the January 2008 CBO report, then the fiscal consolidation this round will be even smaller. Second, the long term budget outlook is considerably different now (as opposed to 1991), with incipient Medicare costs burgeoning.
I wonder if oil prices would have jumped so much without the consumption binge driven by the fiscal profligacy of the past seven years, financial regulatory disarmament, and the housing boom. Some of these factors are being unwound now; but the implications of fiscal decisions made since 2001 remain . Truly, I think Clive Crook has it right — the Bush Administration engaged in “outrageous fiscal excess” that we will paying for for decades.
So, I’d say without further dollar depreciation — most likely against currencies besides the euro — and some fiscal retrenchment, we won’t be seeing an exact replay. (For a cautionary tale, see Bertaut et al. (2008).)