The Problem with Expenditure-Adjusting Policies

Kevin Drum asks the right questions:

So here’s the part where I get confused. The only way to balance our current account is to stop importing more than we export. In other words, we need to reduce our net consumption of foreign goods and services, which almost certainly means an overall reduction in our consumption of goods and services too. On the other hand, a credit-induced recession demands that we stimulate consumption. Otherwise we fall even deeper into recession. So which is it? Increase consumption in order to keep our current recession from turning into a depression, or reduce consumption in order to avoid long-term disaster caused by a growing current-account deficit? Can we somehow do both with an export-driven boom? Is there another option I’m not taking seriously enough? Or are we just screwed?

Jan Tinbergen’s Economic Policy: Principles and Design points out that if you have two policy problems – as in weak aggregate demand and a current account deficit – but only one policy tool (expenditure-adjusting policies such as those that impact domestic consumption), then one is indeed screwed. But we do have expenditure-switching options. I have long favored policies that would lead to dollar devaluation so we could generate even more of an export-driven boom even if John McCain and Lawrence Kudlow want a stronger dollar.