The Soaring Dollar Did It Author(s): ALLEN SINAI Source: Challenge, Vol. 28, No. 4 (SEPTEMBER/OCTOBER 1985), pp. 18-22 Published by: M.E. Sharpe, Inc. Stable URL: http://www.jstor.org/stable/40720372 . Accessed: 11/02/2015 16:00 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. M.E. Sharpe, Inc. is collaborating with JSTOR to digitize, preserve and extend access to Challenge. http://www.jstor.org This content downloaded from 38.88.198.34 on Wed, 11 Feb 2015 16:00:57 PM All use subject to JSTOR Terms and Conditions WhatCaused Inflation to Collapse? TheSoaring Dollar Did It ALLEN SINAI Thedollar's appreciationhas put downwardpressure on oil and commodityprices, restrained wages, and cooled speculative fever.Back-to-back recessions made it all stick,and we had the biggestdisinflation in 30 years. Since 1980, inflationrates have droppedno less than patternsof wage-setting, deregulation, or productivity 11 to 13 percentagepoints. In March 1980 inflation, growth?Did theexceptional rises in thevalue of the measuredon a year-over-yearbasis, was rangingfrom dollarhave a substantialeffect on U.S. inflation? 13.9 percentto 14.7 percent,depending on theindex Five extraordinarydevelopments mark the recent used. By mid-1985, theProducers' Price Index (PPI) disinflationexperience. First, the downturns of 1980 was risingat onlya 1 percentrate and theConsumer and 1981-1982- theonly time in thepast forty years Price Index (CPI-U) was at 3.7 percent,year over whenrecessions occurred in three consecutive years- year.This decline of inflation has beengreater than for createdrecord slack in productand labormarkets and anyother five-year period since the early 1950s. In- pushedprice and wage inflationdownward: manufac- deed, theunexpected shift from a highlyinflationary turing-capacityutilization fell to 68.2 percentin No- environmentto one of disinflation challenges vember1982, a postwarlow. And theunemployment explanation. ratereached 10.7 percent,a postwarhigh. Whateverhappened to inflation?How did so pro- Second, disinflationaryoil price shocksin March nounceda disinflationoccur? Were the recessions of 1983 and February1985 helpedlower inflation. De- 1980and 1981-1982the major cause? Or was itdisin- clinesin OPEC oil pricesfrom $34 to $29 a barrelin flationaryoil- and food-priceshocks? Were there new 1983- $28 morerecently, and still lowersince early special factorsthat came intoplay, such as shifting 1985- reversedthe upwardspiral in oil and energy ALLEN SINAI is ChiefEconomist at ShearsonLehman Brothers, Inc., andAdjunct Professor of Economicsat New YorkUniversity. Thisarticle is basedon a paperpresented by the author and Russell Robins, formerly an economistat ShearsonLehman Brothers, at the EasternEconomic Association Annual Meeting, in March 1985. 18 Challenge/September-October1985 This content downloaded from 38.88.198.34 on Wed, 11 Feb 2015 16:00:57 PM All use subject to JSTOR Terms and Conditions pricesof the 1970s. fromthe dollar? And can thedisinflationary effects of Third,the patternof wage-settingchanged, with the strongdollar linger? employerstending to pass downwardpressure on into as a meansof in prices wages preservinggrowth Whythe dollar soared profits.In more and morewage agreements,lower inflationis now acceptedas an assumption. A keyfactor was theloose-fiscal, tight-money policy Fourth,deregulation of the transportation, banking, mix in the U.S. economysince 1980. Large federal and financialindustries increased competition and budgetdeficits (Table 1) contributedto stronggrowth helped lower inflation,particularly through dimin- and madesubstantially higher nominal and real inter- ishedmonopsony power of unions. estrates inevitable, given the Federal Reserve's strate- Finally,the dollar, as measuredagainst the Morgan gy of targetingmonetary growth. The dollar's rising Guarantytrade-weighted average of fifteenOECD value reflectedpromising growth prospects and high currencies,appreciated by 47.6 percentin nominal realreturns on U.S. investments;its extraordinary ap- termsfrom July 1980 to the end of February1985, preciationwas morethe result of internationalcapital bothdirectly and indirectlylowering inflation. Over thantradable goods flows.A strongerdollar, in turn, theprevious five years the dollar had depreciatedby contributedto a lowerinflation rate. The lowerinfla- 12.1 percent,adding to inflationarypressures. tion rate- giventhe policymix- raisedreal interest Whileall of theseconsiderations have been keyto rates,coming round full circle to strengthenthe dollar. thedisinflation of the 1980s,the role of thedollar is This "virtuous" cycle, a kindof positivefeedback probablythe most significant. Many of thefactors in loop, thenworked to raise theU.S. tradedeficit and the 1980s disinflationprocess stem, at least in part, foreigndebt. U.S. interestrates and thedollar had to fromdollar appreciation. stayhigh enough to attractforeign capital and to curb The effectsof dollar appreciation on inflationwere domesticcapital outflows so thatthe budget and trade bothdirect and indirect.The pricesof goodsand ser- deficitscould be financed.Competitive pressures in vicespurchased abroad declined, directly reducing the theform of falling market shares for the goods side of inflationrates of pricesin variousstages of process- theeconomy, both from rising imports and declining ing. The indirecteffects operated mainly through a growthin exports,intensified the disinflationin the new dimensionof competitionfor U.S. producers- manufacturingsector. Weakness in the tradeable goods importsthat are bothlow in costand highin quality. and manufacturingsectors maintained the slack in The soaringdollar increased, albeit with lags, the rela- productand labor markets,increased price competi- tiveprices of U.S. exportsand lowered the purchasing tion,and helped establish new patterns in wage settle- powerof foreignersfor U.S. goods and services.Im- ments.Downward pressure on oil prices,wages, and portprices, on theother hand, dropped sharply on an speculativeelements of inflationcan all be relatedto absoluteand relative basis, making foreign goods irre- thestrength of the dollar. As a result,we haveexperi- sistibleto Americanconsumers and businesses. encedthe biggest disinflation in thirtyyears. The weakeningof exportsand surgeof imported As thedollar soared, the impact of foreign competi- goods imposeda pricingdiscipline on U.S. business tiongrew. Not onlyhave U.S. consumersand busi- neverexperienced in the postwarera. Competitive nesses expandedtravel and purchasesabroad, but pressureson priceshave been feltkeenly in product moreand moreU.S. manufacturersare usingforeign marketsranging from autos to semiconductors,and componentsand materialsas inputsinto production. theyhave been transmittedto wages and costs. The Americancompanies are increasinglylocating fac- deep slack in the domesticeconomy from the early toriesand establishments abroad. And exports of what 1980s recessionshas helped make the competitive wereonce highly exportable goods, such as agricultur- pressuresstick. Another effect has beenon oil prices, al products,are growingonly slowly, if at all. Thus, withthe strengtheningdollar raisingthe oil bills of by theend of thisyear, the merchandise trade deficit mostnations and thereby dampening their demands for will have morethan doubled since 1983. Withintense oil and energy.This has producedextra pressure on foreigncompetition across a widerange of goods and OPEC to hold oil pricesdown. the diversionof so manypurchases overseas, U.S. Whydid thedollar rise so muchand how did that prices have remained under intense downward lowerinflation? Just how much disinflation has arisen pressure. September-October1985 /Challenge 19 This content downloaded from 38.88.198.34 on Wed, 11 Feb 2015 16:00:57 PM All use subject to JSTOR Terms and Conditions Thedollar and disinflation- sionsthat have lastedthis long, the average change in theprocess real net exportswas a plus $1.5 billion. Recentde- clinesin tradehave cost the United States two to three In the U.S. nowmore to contemporary economy, open of realeconomic each tradeand flowsthan ever the dollar percentagepoints growth quar- capital before, ter.The betweenactual demand and out- affectsinflation in numerous Most obviousare gap potential ways. has remainedwider as a considerable theeffects on the of and services put consequence, prices goods bought losses of have occurred,and therehas been a fromabroad. Basic commoditiessuch as jobs directly food, relatedrise in thefailure rate of business and financial raw andoil become to U.S. metals, materials, cheaper institutions. consumersand At thesame producers. time,however, A fourtheffect is indirect:the combination of in- since foreignershave to make paymentsfor oil and creasedforeign competition, the loss ofmarket shares othercommodities in more expensive dollars, the costs in thetradeable goods industries, outsourcing, and the to foreignersrise and the quantitiesdemanded fall. erosionof goods-producing activities, makes price and Lower costs of materialsto U.S. producerswork cost reductionsnecessary as a response.