G20: Seoul searching on trade and currency

[CHIMO]

It would be great if the leaders of the G20 countries knew a little economics. It might make their meetings more productive and less confrontational. The central area of dispute at the recently concluded meeting was the decision by the Federal Reserve Board to engage in another round of quantitative easing (QE2). This is intended to boost growth by pushing down long-term interest rates.

Lower interest rates will boost consumption by allowing people to refinance their mortgage and will also induce additional investment. QE2 will also likely have the effect of lowering the value of the dollar, as investors sell dollars in search of higher returns in euros, yuan and other currencies. This fact seemed to unite the rest of the G20 in their anger at the United States.

There were numerous lectures coming from various countries that the United States was taking the easy way out. The argument ran that the United States should be correcting its overspending by reducing its budget deficit. The G19 argued that this was better than the US trying to increase growth by using a lower-valued currency to reduce its trade deficit.

Suppose the US did what the G19 urged and quickly reduced its budget deficit. Suppose that it immediately closed its budget deficit by raising taxes by 5 percentage points of GDP and cutting spending by 5 percentage points of GDP. (We'll ignore, for now, the fact that the plunge in GDP would add to the deficit.) Would the G19 then be happy?

http://www.guardian.co.uk/commentisfree/cifamerica/2010/nov/14/g20-economics