*The* lesson from the Great Depression


Because the growth that comes from rising AD strikes our intuition as a sort of “something for nothing” process, we are especially likely to fall into the mistake of thinking in zero sum game terms whenever examining international economic linkages. Common sense suggests that a low yuan cannot help both China and the rest of the world. One country’s trade balance improvement is offset by another’s deterioration. But when you remember that an exchange rate is also a price of money and that the price of money affects both domestic and world AD, things look much different. If during normal times the US suddenly adopted an ultra-tight monetary policy, then the US dollar would appreciate and we’d go into a deep recession. But the rest of the world wouldn’t boom, they’d also suffer an economic slowdown despite the fact that their currencies depreciated against the dollar.