The "Great Moderation" in a Dual Exchange Rate Regime

Sven W. Arndt ()
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Sven W. Arndt: Claremont McKenna College

Global Economy Journal (GEJ), 2012, vol. 12, issue 4, 1-12

Abstract: In the early nineties, the U.S. economy was emerging from a brief slump, monetary policy was easy, and economic activity recovered quickly during the decade, with GDP eventually reaching and then passing the consensus full employment level. Yet aggregate inflation remained surprisingly subdued. This moderation in prices at the aggregate level persuaded policy makers to allow the easy-money stance to continue in spite of the presence of inflation in non-tradables and in housing and construction in particular. This paper uses a flex-price, mixed-exchange rate model to examine some of the major contributing factors to economic developments in the two-decade period that ended in the financial meltdown and the great recession. It argues that Chinese exchange rate manipulation and China's preference for holding dollar reserves were important contributing factors. On the U.S. side, failure to understand the importance of differencial inflation patterns in tradables and non-tradables sectors, and especially failure to see inflation in housing and construction as goods rather than asset inflation, allowed monetary expansion to last much longer than it should have.

Keywords: open-economy macro; mixed exchange rates; non-tradables; asset inflation (search for similar items in EconPapers)
Date: 2012
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DOI: 10.1515/1524-5861.1900

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