Hang-Sheng Cheng

Jack H. Beebe

English

Research Papers in Economics

FRBSF WEEKLY LETTER
February 2, 1990
A Net Export-Led Downturn?
and resource allocation that can seriously impair
the economy's productive efficiency.
In concert with this rapid growth, inflation
remained above four percent (see Chart 2).
U.S. interest rates reversed the downward trend
observed from 1980 through 1986, rising steadily
through early 1989, except for a brief decline
after the October 1987 stock-market crash
(Chart 3). To keep inflation under control,
The sustainable growth rate depends on the rate
of growth in the economy's productive capacity,
or aggregate supply. Our best estimate is that
productive capacity currently is growing at an
average rate of approximately 2112 to three per-
cent per year. (The rate of productivity growth
appears to have accelerated during the 1980s,
but slower labor force growth has offset some
of the effects of productivity advances.)
Percent
7
6
5
4
3
____ 2-____
1
• US II Germany. Japan
1987 1988 1989
u.s. data for 1988 and 1989 are drought adjusted.
1989 estimates based on 3quarters.
Chart 1
Real GNP
4Q/4Q Growth Rates
Using this range as a gauge of economic per-
formance, it is clear that growth in 1987 and
1988, at rates of 5.4 and (drought-adjusted) 4.0
percent, respectively, was well above the sustain-
able rate (See Chart 1). During this period, the
civilian unemployment rate fell from 6.7 percent
to 5.3 percent, a figure somewhat below the 5.5
to 6.0 percent rate that probably is consistent
with stable wage inflation.
The U.S. economy is now in the eighth year of
the longest peacetime expansion in its recorded
history. However, slower growth in consumer
spending and business investment, together with
new weakness in certain sectors such as autos,
have raised concerns over the sustainability of
this expansion. One of the factors often cited as
contributing to the economy's potential lull is the
strength of the dollar over the past two years and
the export slowdown in the second half of 1989.
Indeed, forecasters are saying that even with
modest depreciation in the dollar, net exports
(exports minus imports) probably will have a
negative influence on U.S. growth in 1990, after
having had a strongly positive impact from 1987
through mid-1989.
Although exports constitute only 10 percent of
U.S. output, growth in net foreign demand for
u.s. goods and services (real net exports) has
accounted for 21 percent of u.s. output expan-
sion since 1986. To a considerable extent, there-
fore, prospects for the u.s. economy depend on
those of our major trading partners.
Sustainable growth
Surges in aggregate demand, stimulated either
by private spending or by government policy,
can temporarily lift output growth above the
economy's "sustainable growth rate:' defined
as the rate of growth that would maintain a con-
stant rate of inflation. However, such surges in
demand can create distortions in relative prices
Experience indicates that economic devel-
opments abroad can either reinforce or offset
developments in the u.s. For example, simul-
taneous expansions in the major industrial econ-
omies during the early 1970s and simultaneous
contractions during the early 1980s had mutually
reinforcing effects that caused severe world
economic instability. But there also have been
periods in which these economies moved in
ways that had mutually stabilizing effects. (See
--the-tetterof-November--:3-,-1~8~~)-Thepresent-­
situation and what lies ahead may prove to be
an example of the latter.FRBSF
U.S. monetary policy tightened over this period.
Tighter policy, in turn, undoubtedly was a signifi-
cant factor behind the rise in the international
value of the dollar during 1988 and early 1989,
and ultimately, slower U.s. growth in 1989.
to their strongly positive contribution through
mid-1989. How closely the behavior of u.s. net
exports in 1990 follows this prediction will
depend in part on the outlook for the world
economy.
Chart 2
Consumer Price Index
Moving Averages of Past 12 Months
...'.. .....
Germany ....... ....
..t"':":..;.;..:........:.:..:'I.··II•••
Percent
6
4
2
o
The global context
The rate of economic growth varies across the
major industrialized countries, with the U.s.,
Canada, and the U.K. at the lower end of the
scale. Most others remain considerably stronger
heading into 1990 than was expected a year ago.
Strong economic growth is particularly evident
in continental Europe, Japan, and the rapidly
growing economies in the Pacific Basin region.
Among the industrial countries, economic de-
velopments in two leading members-Japan and
West Germany-will have an important impact
on U.s. net exports and growth.
Indeed, growth in 1989 averaged only 2.3 per-
cent over the first three quarters (abstracting from
..-tbebouncebackfrom-thedroughtl.E¥er:t.atinis
slower growth rate, however, the civilian unem-
ployment rate ended the year at 5.3 percent, the
same rate as recorded at the end of 1988.
Chart 3
Eurocurrency Deposit Rates
1987 1988
Japan enjoyed sustained economic growth and
relative price stability during most of the 1980s.
From 1980 to 1985, a rising trade surplus, aided
by steady yen depreciation, provided a major
stimulus to Japan's economic growth, which
averaged four percent a year during this period.
The precipitous yen appreciation from 1985
through 1987 caused Japan's trade surplus (in
real terms) to fall and output growth to slow to
2.1 percent over the four quarters of 1986, sub-
stantially below Japan's growth potential.
Then, in 1987, accommodative monetary policy
and industrial adjustments to the rising value of
the yen boosted domestic business investment,
residential construction, and household con-
sumption. Output growth rose to 5.7 percent
in 1987 and 4.8 percent in 1988, with rapid
expansion in domestic demand more than com-
pensating for the shrinking trade surplus. In 1989,
output growth spurted to an average rate of 6.4
-.- -.peJCent.o.verth~dil"st-threeq.uarters-of.l98.9-, ..-
higher than what is generally regarded as a
sustainable rate for the Japanese economy.
-2
Percent
12
10
8
6
4
2
1989
1989 1988 1987
Forecasters expect even slower growth in 1990,
with most calling for a growth rate of between
1.5 and 2.5 percent on a fourth quarter over
fourth quarter basis. These forecasts are
predicated on somewhat slower u.s. domestic
demand growth. But importantly, they also pre-
sume that net exports will make either a very
small positive, or more commonly, a negative
contribution to growth in 1990, in sharp contrast
During the late 1980s inflation also began to rise.
From less than one percent a year in 1987 and
1988, the consumer price inflation rate climbed
to three percent in 1989 (Chart 2). Among the
major industrial countries, Japan alone had not
tightened monetary policy in 1988 because there
appeared to be little sign of overheating in its
economy. In May, October, and again in Decem-
ber 1989, however, it too raised its central-bank
discount rate (Chart 3).Compared with Japan, West Germany's output
growth rate was relatively low, averaging 2.2
percent a year from 1983 to 1987. As a result of
policies that favored domestic price stability
over short-term output gains, Germany's con-
sumer price inflation rate fell from an average
of 2.6 percent a year in 1983-85 to zero in
1986-87.
At the same time, developments in East Germany
and throughout Eastern Europe are placing new
pressures on West Germany and the economies
of Western Europe. In the short run there are
.... -·liKelyTo·oeTncreasecraemana-pressuresinWesf
Germany, giving further upward momentum to
the German interest rate and exchange rate.
Indeed, since July, the u.s. dollar has fallen
However, in the face of a steadv currencv aD-
preciatio~ and a stubborn eightpercent ~n~m­
ployment rate, monetary policy eased somewhat
in 1986 and again in 1987. Domestic business
investment responded strongly. National output
rose by 3.4 percent in 1988 and 3.5 percent over
the first three quarters of 1989. With rapid de-
mand growth, West German consumer price in-
flation accelerated from about one percent in
mid-1988 to three percent in 1989. The German
central bank has responded strongly to this
surge, raising interest rates four percentage
points since June 1988 (Chart 3), far in excess of
the two percentage point rise in consumer price
inflation.
Hang-Sheng Cheng
Vice President,
International Studies
Jack H. Beebe
Senior Vice President and
Director of Research
Implications
The surprising strength of the Japanese, West
German, and other European Community (Ee)
economies probably will lead to continued in-
creases in their interest rates and exchange rates.
This combination of strong foreign economic
growth and further declines in the value of the
dollar should bolster the demand for u.S. ex-
ports. At the same time, U.S. import demand will
slow down due to more sluggish U.S. economic
growth and rising foreign currencies. Conse-
quently, U.s. net export growth may not be as
weak as feared.
more than 15 percent against the West German
mark, with most of the movement since Septem-
ber. Because of the system of pegged exchange
rates within the European Monetary System, the
dollar has fallen almost as much against the other
members' currencies as well.
In summary, recent international events provide
an interesting example of the international
repercussions of external economic develop-
ments. In an attempt to stabilize U.s. inflation,
the Federal Reserve tightened policy through
early 1989. Relatively tight U.S. monetary policy
probably was a major factor behind the dollar's
rise from late 1987 through mid-1989. In recent
months, subsiding growth and inflation in the
U.S. have led to declining U.S. interest rates,
while continued strength abroad, particularly in
Japan and West Germany, has resulted in further
increases in foreign interest rates. The effects of
these divergent movements should be felt in the
U.S. through strong foreign aggregate demand
and through a weaker dollar, which will tend to
mitigate both the expected deterioration in U.S.
net exports and the lull in U.S. output growth.
Thus, it is likely that even through our economy
has slowed, the continuing strength of the econo-
mies of our major trading partners should have a
stabilizing effect on U.s. economic growth in the
near future.
90
50
70
80
60
Jan. 1986=100
100
1990 1989 1988 1987
Chart 4
U.S. Exchange Rate
Weekly Averages through January 12
•Multilateral trade·welghted against Japan, Canada, and
8 European currencies.
Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Barbara Bennett) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.Research Department
Federal Reserve
Bank of
San Francisco
P.O. Box 7702
San Francisco, CA 94120

A net export-led downturn?

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A net export-led downturn?

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