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The Fault Is … in Ourselves

Summary:
Or more correctly, in Mr. Trump. As reported by Bloomberg, Mr. Trump has said: “a gentleman that likes raising interest rates in the Fed, we have a gentleman that loves quantitative tightening in the Fed, we have a gentleman that likes a very strong dollar in the Fed.” I think Mr. Trump is partly himself to blame for the strength of the dollar. To show this, I estimate the following relationship over 2014Q1-18Q3, with r the log real trade weighted value of the US dollar, EPU world economic policy uncertainty as measured by Baker, Bloom and Davis, y is log real GDP, i  is the policy rate (shadow Fed funds for US), and “RoAdv” denotes rest-of-advanced economies. r = -0.123 + 0.054EPU + 2.209(y-yRoAdv) + 1.227(i-iRoAdv) + u Adj.-R2 = 0.86, N=19, DW = 0.89. bold denotes significant at the 5%

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Or more correctly, in Mr. Trump. As reported by Bloomberg, Mr. Trump has said:

“a gentleman that likes raising interest rates in the Fed, we have a gentleman that loves quantitative tightening in the Fed, we have a gentleman that likes a very strong dollar in the Fed.”

I think Mr. Trump is partly himself to blame for the strength of the dollar. To show this, I estimate the following relationship over 2014Q1-18Q3, with r the log real trade weighted value of the US dollar, EPU world economic policy uncertainty as measured by Baker, Bloom and Davis, y is log real GDP, i  is the policy rate (shadow Fed funds for US), and “RoAdv” denotes rest-of-advanced economies.

r = -0.123 + 0.054EPU + 2.209(y-yRoAdv) + 1.227(i-iRoAdv) + u

Adj.-R2 = 0.86, N=19, DW = 0.89. bold denotes significant at the 5% MSL using HAC robust standard errors.

Using these estimates, I can decompose the movement in the real US dollar since 2014Q1.

The Fault Is … in Ourselves

Figure 1: Contributions to change in real value of trade weighted US dollar since 2014Q1 (up is appreciation), arising from the policy interest rate differential (teal), from GDP differentials (red) and from global economic policy uncertainty (dark blue). US interest rate is shadow Fed funds. Orange shading denotes Trump administration. Source: Federal Reserve Board, Xia-Wu, Dallas Fed, Baker, Bloom and Davis via policyuncertainty.com, and author’s calculations.

Notice that the Brexit induced a substantial increase in the dollar’s strength. But since the election of Mr. Trump, a substantial share of the increase in the dollar’s value has come from the growth differential in favor of the US (of which at least some comes from the TCJA and the relaxation of spending restrictions in the budget bill), and since 2018Q2 — with elevated global economic policy uncertainty. As I’ve noted elsewhere, this event has coincided with an elevation of US trade policy uncertainty, as measured by the BBD categorical index for this category. Here, Mr. Trump has only himself to blame.

Hence, we can say that at least some of the dollar’s strength is due to Mr. Trump’s own actions.

Menzie Chinn
He is Professor of Public Affairs and Economics at the University of Wisconsin, Madison

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