Courtesy Reuters

American Economic Policy and the World Economy

During the past few years, the American economy has demonstrated impressive resiliency and America’s economic performance has improved substantially. Inflation has dropped from 13 percent to four percent. The rise in unemployment that was an inevitable consequence of the accelerating inflation of the late 1970s has retreated to just a fraction over seven percent. And real GNP has increased more than 12 percent in the two years since the recovery began.

Much of this progress has been mirrored in other industrial countries. Inflation is down throughout Western Europe and real GNP is rising. Unfortunately, though, unemployment rates remain extremely high.

The experience of the past few years has underlined the interdependence of the world economy. Sharp changes in international trade, in capital flows and in exchange rates have affected all major economies. The rise in real interest rates everywhere reflects the close links among capital markets.

I believe that the U.S. budget deficit has been the dominant influence on the world economy during the past two years and that the coming resolution of America’s fiscal imbalance will have profound effects during the years ahead. It is America’s budget deficit that has been the primary cause of the high real interest rates and therefore of the rising dollar. By increasing American imports and depressing our exports, the over-strong dollar has proven to be a direct stimulus to the economies of Europe, Japan and Latin America.

But, at the same time, the American budget deficit has raised real interest rates in the world capital market and induced European governments to pursue contractionary monetary and fiscal policies aimed at offsetting the inflationary pressure caused by the fall in their own currency values. The poor performance of European investment and employment is due in no small part to the budget deficits in the United States.

I am optimistic about the prospects for legislation that will reduce future budget deficits. That deficit reduction may not prove to be as much as I would like,

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