interactionary

The Soft Landing Scenario

Macroblog fills in the outlines of its soft-landing scenario:

macroblog: Exactly What Was I Thinking?: Actually, the story I was telling was all about reversing the big capital inflows and trade deficits, one that starts with the presumption that foreigner’s taste for absorbing ever more dollar-denominated assets has come to an end.  The current account side of ending the capital account surpluses — that is, the accumulation by foreigners of U.S. Treasury securities and the like — is a shrinking trade deficit, as the weaker dollar stimulates export demand and restrains the demand for imports.

In this scenario, spending by American consumers and businesses will have to be satisfied by domestic production.  That will almost certainly result in upward pressure on interest rates, which ought to work in the direction of restraining domestic consumption and increase saving rates (and business investment on plant and equipment, of course), as required.

To restate: (1) the dollar falls, (2) as a result net exports rise, (3) export and importing-competing industries hire workers, (4) unemployment falls, (5) wages start rising and bring rising inflation with them, (6) the Federal Reserve raises interest rates to stop any inflationary spiral, (7) the economy cools off as higher interest rates reduce construction and investment spending and raise unemployment back to its natural rate.

It could happen–if exports react rapidly and substantially to the falling dollar, and if the rising long-term interest rates that diminish employment in construction and investment-goods production are somewhat delayed…

 

from Brad DeLong