Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99.
Exactly 30 years ago, on September 22, 1985, ministers of the Group of Five countries met at the Plaza Hotel in New York and agreed on a successful initiative to reverse what had been a dangerously overvalued dollar. The Plaza Accord was backed up by intervention in the foreign exchange market. The change in policy had the desired effect over the next few years: bringing down the dollar, reducing the US trade deficit and defusing protectionist pressures. Many economists think that foreign exchange intervention cannot have effects unless it also changes money supplies. But the Plaza and a number of subsequent episodes of concerted intervention by the G-7 countries suggest otherwise.
In recent years foreign exchange intervention has died out among the largest industrialized countries. Seeing as how the dollar is again strong and the US Congress once again has trade concerns, some have asked if it might be time for a new Plaza. My answer is “no, not even close.” The value of the dollar is not as high now as it was in 1985. More importantly, its recent appreciation is based on the economic fundamentals of the US economy and monetary policy, measured relative to those of our trading partners, whereas in 1985 the appreciation had continued well past the point justified by fundamentals.
The Baker Institute at Rice University is holding a conference on Currency Policy Then and Now: 30th Anniversary of the Plaza Accord. Among the key figures participating is James Baker, who as the new Treasury Secretary that year was the main initiator of the agreement. My paper for the conference, “The Plaza Accord, Thirty Years Later,” reviews 1985’s coordinated policy of intervention in the foreign exchange market and contrasts it with the current “anti-Plaza,” a recent G-7 agreement not to intervene. I see fears of “currency wars” as way over-done.
The post written by Jeffrey Frankel.
Seeing as how the dollar is again strong and the US Congress once again has trade concerns, some have asked if it might be time for a new Plaza. My answer is “no, not even close.”
Yet the trade deficit as a percentage of GDP is much worse than in 1985. The trade deficit means fewer jobs and lower wages for U.S. workers. How else to you propose to fix that?
Trade deficits mean the country is consuming more than producing in the global economy, and when the U.S. moves towards full employment, trade deficits have worsened.
It’s not our problem. If foreigners want to work for free, why stop them? There are other ways to raise wages and employment than working for free, including refunding trade deficit dollars spent by U.S. producers and consumers.
Actually, I don’t think the trade deficit as a percentage of GDP in fact “is much worse than in 1985.” But in any case I don’t agree that the strong dollar and trade deficit means fewer jobs. If today we had a weaker dollar and stronger trade balance, then the Fed would have raised interest rates by now, before output and employment could get much higher than they currently are. TIghter monetary policy would then have crowded out some other component of demand, such as construction. So under current conditions, the exchange rate may affect the composition of GDP (net exports versus domestic demand) but it doesn’t determine total GDP or total employment.
I think the solution for higher real wages lies elsewhere. Such as universal pre-school education. (Also we could address the stagnating real incomes of workers by such measures as expanding the earned-income tax credit, shifting up the contribution thresholds for social security, etc.)
Thanks for your comment, though.
The dollar was bound to fall from its rather dramatic overvaluation even without the Plaza Accord. In my view, all the Accord did was to precipitate what was surely coming anyway.
Intervention is largely a way for currency traders to make money, as long as it is not accompanied by seriously binding capital controls.
“Actually, I don’t think the trade deficit as a percentage of GDP in fact “is much worse than in 1985.””
Well, according to FRED, in Q1/1985 it was -2.1% and in Q1/2015 it was -2.7%, so if the trade deficit in 1985 merited action, I’m not sure why the trade deficit today doesn’t.
“But in any case I don’t agree that the strong dollar and trade deficit means fewer jobs.”
A strong dollar, evidenced by a large trade deficit, is no different than a tariff on U.S. exports. Most economists would be violently opposed to tariffs. Certainly a tariff on U.S. exports would be regarded by most economists as reducing jobs in the U.S.
“If today we had a weaker dollar and stronger trade balance, then the Fed would have raised interest rates by now, before output and employment could get much higher than they currently are.”
All you are saying here is that the Fed will do anything necessary to suppress wages. It don’t doubt that unfortunate fact, but that is true no matter what the cause. It seems you are saying we should be satisfied with suppression of wages whether by exchange rate or by Fed actions.
“I think the solution for higher real wages lies elsewhere. Such as universal pre-school education.”
So your solution is that we just cool our heels for the next twenty years and patiently wait for pre-school education to fix the problem of stagnate wages? Seems like a convenient way of ducking the issue. Pre-school education that is by no means forthcoming, by the way.
Interesting paper. In general I agree with you especially in your response to Joseph’s confused economics.
My difference is that the economic climate of 1985 was much different from the climate of today. Actions by the new financial team of President Reagan was know to be monetarist. Treasury Secretary James Baker III was known to favor weakening the dollar causing concern on foreign markets (see Peter T. Kilborn in The New York Times 1987). White House Chief of Staff Don Regan was forced out and replaced by Sen. Howard Baker who favored raising taxes and trade sanctions on Japan. Finally, Paul Volker who had engineered and was a defender of stable exchange rates was replaced by Alan Greenspan who favored floating exchange rates. Evans & Novak wrote a column aptly titled “Reagan’s Surrender.” The result of the interventions of this new finance team was Black Monday on October 19, 1987.