Financial Times (Letters), 7th January 2008
Comment on Willem Buiter’s FT article “The silver lining in sterling’s decline.” 4th January.
I share Willem’s view that although currency forecasting is a dubious activity it seems likely that sterling will fall. (This is all the more reasonable since the internationally agreed (SNA) way of treating net foreign portfolio and direct investment differently means that the latest current account deficit of 5.7% of GDP is likely to be a significant understatement of the “real” deficit – a point that Wynne Godley has also been making.)
It is, however, quite likely that the silver lining will prove to be tarnished by a fall in the UK’s growth rate as demand switches from domestic consumption to net exports.
A marked feature of the past 15 years or so among G5 countries has been that the UK and US have grown most rapidly, despite the lowest ratios of investment, particularly private non-residential, to GDP. The superior ICORs have been associated with high and rising external deficits. As traded goods form a larger part of international trade than of domestic output, this combination can be explained as a consequence of the higher capital output ratios of traded goods.
As large and rising external deficits are not sustainable, it is reasonable to assume that the superior ICORs will also fall away, or even reverse. Investment should rise over time in the UK and US, but the switch from consumption to investment and exports is likely to be associated with weaker medium-term growth and productivity.
While weaker sterling and dollar should help rebalance these economies, the wage growth rates compatible with stable inflation will fall. Weaker exchange rates will then require higher output gaps and higher unemployment.omment on Willem Buiter’s FT article “[b]The silver lining in sterling’s decline.[/b]” 4th January.
I share Willem’s view that although currency forecasting is a dubious activity it seems likely that sterling will fall. (This is all the more reasonable since the internationally agreed (SNA) way of treating net foreign portfolio and direct investment differently means that the latest current account deficit of 5.7% of GDP is likely to be a significant understatement of the “real” deficit – a point that Wynne Godley has also been making.)
It is, however, quite likely that the silver lining will prove to be tarnished by a fall in the UK’s growth rate as demand switches from domestic consumption to net exports.
A marked feature of the past 15 years or so among G5 countries has been that the UK and US have grown most rapidly, despite the lowest ratios of investment, particularly private non-residential, to GDP. The superior ICORs have been associated with high and rising external deficits. As traded goods form a larger part of international trade than of domestic output, this combination can be explained as a consequence of the higher capital output ratios of traded goods.
As large and rising external deficits are not sustainable, it is reasonable to assume that the superior ICORs will also fall away, or even reverse. Investment should rise over time in the UK and US, but the switch from consumption to investment and exports is likely to be associated with weaker medium-term growth and productivity.
While weaker sterling and dollar should help rebalance these economies, the wage growth rates compatible with stable inflation will fall. Weaker exchange rates will then require higher output gaps and higher unemployment.