- A government establishes a sane, balanced long-run fiscal policy.
- Businesses conclude that the country is a safe one in which to invest to build export capacity: since they do not fear future random and confiscatory taxation or inflation, factories making internationally-traded goods that would have been built abroad are built here at home instead.
- With more export capacity at home and less abroad, exports rise and imports shrink at the current exchange rate.
- Supply and demand leads the domestic currency to appreciate in order to balance trade.
Rubin's channel is: good fiscal policy --> expanded export supply --> export surplus --> higher currency value.
By contrast, Krugman's channel is: good fiscal policy --> lower domestic interest rates --> reduced currency value --> export surplus.
Which side am I on? I tell my undergraduates:
-
At a time horizon of 0-3 years, be a Keynesian: the most important things are the fluctuations in unemployment, in real demand, and in capacity utilization.
-
At a time horizon of 3-8 years, be a demand-side monetarist: you can assume (provisionally) that fluctuations in employment, real demand, and capacity utilization die out; the most important things are the fluctuations in the composition of real demand (investment vs. consumption vs. government vs. net exports) and in inflation- and deflation-causing nominal demand assuming (provisionally) stable growth of the economy's productive capacity.
-
At a time horizon of 8 years or greater, be a sane supply-sider: the most important things are the processes of investment in physical, human, and organizational capital that raise the economy's productive capacity.
Thus I was happy telling my undergraduates in 1985 that the reason the dollar was strong was because of the five years of Reagan deficits--high domestic interest rates, you see, pushing up the value of the dollar (and raising the trade deficit). And I was happy in 1992 telling my undergraduates that the reason the dollar was weak was because of the twelve years of Reagan-Bush deficits--large budget deficits starving the economy of capital that made us less productive than in some counterfactual in which we had elected some Eisenhower Republican in 1981.
