Speaker unverified: belief

Transcript context

…That puzzles me all the more. If we think of Australia, which does not have exorbitant privilege, as you know, they ran trade deficits for decades steadily. There was no reason to think Australian demand would suddenly collapse. Australia’s done fine, has strong fundamentals, yet the intertemporal constraint on that process, it never seems pushed into the present. Why is the inter-temporal constraint so weak, and how should that shape how we think about how economies actually work? Is everything just flashed period by period, like in the very simple Keynesian models, or is it something else? Well, it is a constraint that says that if you have net foreign liabilities to the rest of the world, then in a present discounted sense, at some point you have to be running surpluses to be able to pay that off. That’s the only thing that that constraint says, and that can happen through a combination of things. It can happen either because you have a discovery of a resource that you then export to the rest of the world and therefore your exports start booming because of that, or you have a recession in your country, and imports collapse. The real exchange rate does play a role. To be clear, I am not saying that the real exchange rate never comes into play; it does. You have seen countries whose incomes have grown over time, have had their real exchange rates appreciate; it just takes a long period of time. To assume that on a year-to-year basis that if a country is running a trade balance deficit, it should necessarily have a weaker real exchange rate, I think making that tight link would be problematic not just from the theory, but from the theory side and from the empirical side. Now when exchange rates move, as you well know and have written plenty about, there’s very often not that much pass-through to the prices of imports and exports. That seems to be another case where relative prices, at least superficially, are not mattering in the way we would expect them to. What’s your best explanation for that?…

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