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Net Exports, the Exchange Rate, and an IS-Led Boom


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The Boom of the Late 1990s and the American Trade Deficit

The large American investment-led boom of the late 1990s also saw steeply falling and largely negative net exports--a big trade deficit. These circumstances--high investment, high output and low unemployment, and a large trade deficit--were related.

Begin the story with the burst of enthusiasm for high-tech in the second half of the 1990s. Businesses spent fortunes investing in computer and communications equipment. This sudden rise in the baseline level of investment I0 pushed the IS Curve out and to the right (1). The Federal Reserve responded by allowing real interest rates to rise: the FOMC was unwilling to increase the money stock enough to fully accomodate the increase in investment demand, so the outward shift in the IS curve was accompanied by rising real interest rates (2).

Rising real interest rates generated a fall in the exchange rate--a reduction in the value of foreign currency (3). With foreign currency worth less, U.S. goods became more expensive to foreign purchasers, and exports fell as a share of GDP (4).

Moreover, the rising levels of output associated with the boom raised Americans' real incomes (5). And higher real incomes meant higher imports as well (6). Since net exports are equal to gross exports minus imports, and since gross exports fell and imports rose, net exports fell as the boom of the 1990s continued.

Previous Handouts

2001-11-19: The European Central Bank and Its Monetary Policy (Chapter 13: Stabilization Policy)
2001-11-12: Central Banks Worldwide Cut Interest Rates Again (Chapter 13: Stabilization Policy)
2001-11-05: Effects of the Collapse in Spending on Durables (Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-28: What Kind of Stimulus (Chapter 13: Stabilization Policy. Chapter 9: Income-Expenditure and the Multiplier.)
2001-10-21: Federal Reserve Reaction to the Terror Attack on the World Trade Center (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)
2001-10-14: Why a Stimulus Package Might Be Desireable (Chapter 13: Stabilization Policy. Chapter 10: The IS Curve.)

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