The Dollar: A Victim of the Classical Keynesian Divide

Last year I said that I felt about a strong dollar like St. Augustine felt about chastity. "Lord, make me chaste, but not just yet." My version was, "Lord, give us a strong dollar, but not just yet."

My point was that while a strong dollar had benefits in normal times it would make a recession worse and more difficult to recover from. If someone from on high decrees a stronger dollar in a recession, our exports would be more expensive to potential foreign importers and imports would be more affordable to us at home. The decline implied for net exports pulls down GDP.

On the other hand, if aggregate demand is sufficient for a reasonably full-employment economy, then a weak dollar is not needed for recovery and a strong dollar will raise our standard of living. It makes it cheaper to import goods and services from abroad and it keeps domestic producers' and potential exporters' feet to the fire to maintain competitiveness. I haven't heard the term in a long time, but it improves our terms of trade. That means we don't have to pay as much in exports for a given amount of imports.

The dollar is but one example of the confusion that arises if you aren't clear about whether you are in a "normal" classical world where efficiency and rising living standards are the issue or whether you have to adopt Keynesian thinking to get out of recession.  I never quite understood why, but Keynes was almost a dirty word among most of my professors. It just seemed to me that his General Theory  was special-case economics and it wasn't worth getting all worked up about. (Of course I kept that sentiment to myself on exams.)

It seems too simplistic, but I think the main problem was that Keynes's emphasis on making up shortfalls in private spending with government spending was interpreted as his being a "big government" man. So much emphasis on government spending seemed inconsistent with their belief in a free enterprise system. So, you were either for the government or for the market. They didn't buy the "special case" argument or the idea that you might have to deviate from the ideal a little to save it. That reluctance lives on today.

Comments (2)

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  1. I agree with you. I see Keynes as advocating a plan very similar to the Chicago Plan of 1933, and his overall view comes close to Milton Friedman’s in the essay “A Monetary and Fiscal Framework for Economic Stability”. I also see Hayek and Friedman as being much more pragmatic than many others do. I attribute the more emphatic defense of many of my heroes of small govt after WW II to what I call “The Ratcheting Effect”, or “The Road to Serfdom Effect”.

    After the war, Keynes was seen as endorsing the growth of govt. in general. I do not agree that this was his view. For many years, I think that TRE and TRTSE seemed very plausible. I simply feel that my heroes underestimated the resilience and balance of forces of the Welfare State. To me, a Welfare State is a Capitalist State with a high amount of govt interference. It is not Socialism. Within a Welfare State, the debate centers around how much intervention the state should conduct, and how best to accomplish the goals of these interventions. Following my views of Burke and Hayek, this system is an organic development that arose from different views and interests jockeying in the real world. I don’t see it going anywhere. Even in this crisis, I thought that Nationalism might be a problem, but the Welfare State isn’t going anywhere.

    My entire political argument is that if we follow the pragmatic proposals of my heroes, we can have a much smaller govt that accomplishes many of the goals that WS adherents desire.

    Hence, I advocate a Negative Income Tax/ Guaranteed Income, Milton Friedman’s Health Plan with a slight variation, and the plan put forward in the MF essay I mentioned earlier, among other things.

    I’m not much of a theory or ideology man, but, when I’m in the mood, I read David Friedman’s “The Machinery Of Freedom”.

    Of course, I still believe that I am the least agreed with commenter on economic blogs.

  2. Wally K says:

    Bob, not to worry. The dollar may rise temporarily for technical reasons but there isn’t one person in the present administration who wants a strong dollar so don’t sell your gold just yet.

    By the way, thanks for the great Blog. It is a pleasure to read someone who actually knows how the economy {and especially the Fed) really works and can explain it in understandable terms.