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The original documents are located in Box B2, folder "Balance of Payments (1)" of the
Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date March 7, 1969.
To
Board of Governors
Subject: Euro-dollar Borrowings and
From
Robert Solomon
C.D. Attrition
I commend to the Board's attention the attached
analysis by Mr. Hersey. This note was specifically inspired
by Governor Maisel's remarks at the Money Market Review on
February 28, but it is also of more general significance. It
states an analytical conclusion--that Euro-dollar borrowings
do not add to total credit availability or affect the general
level of interest rates in the U.S. economy, whatever their
effect in helping the borrowing banks to postpone adjustments
in their investments and loans--a conclusion to which my
colleagues and I have come as we continue to think about the
process of Euro-dollar borrowings.
RS
Attachment.
Chron- memo
FORD & GERALD LIBRARY
To:
Mr. Robert Solomon
Subject: Borrowing of Euro-dollars
From: A. B. Hersey
as an Offset to CD Attrition
The first part of this memorandum summarizes very briefly
the mechanisms of what happens when U.S. banks offset CD attrition
by borrowing Euro-dollars. The second part takes note of some
results. The third part deals with the question of what "leakages"
can be said to be involved if we look at the borrowing of Euro-
dollars as a credit expansion process. (The term "leakages" is
used here in the sense in which it is used in multiplier theory.)
This leads into the question of limits on the use of Euro-dollars.
Mechanics of U.S. banks' borrowing Euro-dollars.
What happens when banks losing large-denomination CD
money attempt to avoid asset adjustments by borrowing Euro-dollars
through their branches? (Let us disregard the bidding of deposits
away from one bank by another.) New Euro-dollar deposits come into
existence as part of a process typified by the following events:
(1) some foreign business or bank shifts out of liquid assets in
some other currency into Euro-dollars, disposing of its former asset
in a foreign money market and buying dollars in the foreign exchange
market; it may either acquire a Euro-dollar deposit or repay a Euro-
dollar loan; (2) a foreign central bank, selling dollars in the
foreign exchange market, liquidates U.S. Treasury bills in the U.S.
FORD is LIBRARY GERALD
To: Mr. Robert Solomon
2 -
market to replenish the working account from which its dollar sales
are made; (3) some U.S. short-term investor acquires the Treasury
bills.
The first two elements of the process were very clearly
evident in January when German banks were moving into Euro-dollars
on an unusually large scale and the Bundesbank was losing reserves
heavily. At times when movements into Euro-dollars are smaller than
they were in January, the association of reserve changes with move-
ments into Euro-dollars may show up less clearly, taking the form of
a smaller gain in foreign official reserves than would otherwise have
occurred.
Results for U.S. bank assets, bank liquidity, and total credit.
1. The process described above is thought of as being
triggered by U.S. banks' bidding for Euro-dollar funds in consequence
of CD attrition. Suppose now that the U.S. banks had not succeeded
in getting additional Euro-dollars. In that case they would have
had to make other adjustments -- in the Federal funds market, at the
Federal Reserve discount window, or by selling Treasury bills or
other assets. Thus one result of the successful bidding -- assuming
that the Euro-dollar borrowing are for a reasonably long period such
as a month or more -- is that the banks involved temporarily escape
the need for making other adjustments. In comparison with the alterna-
tive of selling bills, they keep their total assets and liabilities
FORD & LIBRARY 078870
To: Mr. Robert Solomon
- 3 -
larger than they would otherwise have been. They retain a cushion
of liquidity they would otherwise have lost.
2. The reserve requirements of the banks suffering CD
attrition are reduced by 6 per cent of the loss of CD's. Whatever
effects this may have, given Federal Reserve policy actions at the
time, will be the same whether or not the banks offset the CD attri-
tion by obtaining Euro-dollar funds not subject to reserve require-
ments. However, in so far as Federal Reserve policy actions are
geared to total bank credit or to the bank credit proxy adjusted for
Euro-dollars (rather than to the unadjusted proxy), successful bidding
for Euro-dollars (which makes bank assets larger than they would other-
wise be) may cause Federal Reserve policy shortly afterwards to be
slightly more restrictive, and interest rates slightly higher, than
if the banks had failed to obtain the Euro-dollars and so had had to
reduce their assets.
3. Disregarding effects mentioned in the preceding para-
graph, whether CD attrition is accompanied by successful bidding for
foreign funds through the Euro-dollar market or by unsuccessful bidding
and then by asset adjustments or other borrowings, in either case the
U.S. banks' actions have the effect of transmitting liquidity pressures out
into U.S. financial markets. In the first case, foreign central banks
are impelled to sell U.S. Treasury bills (or buy fewer than otherwise);
in the second case, the U.S. banks themselves transmit the pressure
name
FORD & LIBRARY 076870
To: Mr. Robert Solomon
- 4 -
through bill sales or other adjustments. To repeat, even though
banks that borrow Euro-dollars escape immediate pressure themselves,
their actions have the effect of passing on pressure to the rest of
the system.
4. Similarly, whether or not the bidding for additional
funds through the Euro-dollar market is successful, nonbank creditors
in the United States who (in the aggregate) are giving up CD's will
(in the aggregate) have to absorb Treasury bills or similar instruments --
from foreign central banks in one case, from the U.S. banks in the other --
so that in either case total credit for U.S. residents will be unaffected.
1/ Asset adjustments either by the foreign central banks or by the
banks suffering CD attrition clearly tend to transmit pressure; some
other bank must lose reserves in settlement for purchases of the assets sold.
Borrowing at the Federal Reserve discount window does not transmit liquidity
pressures to other parts of the system; instead the borrowing bank it-
self remains under pressure to make adjustments; the transmission of pres-
sures is thus merely delayed. The analysis here skips entirely the ques-
tion of what expansive effects on the reserve position of other banks the
withdrawal of CD's (from banks that borrow Euro-dollars) may have. We
might assume, for example, that Federal Reserve policy is sufficiently
restrictive to cancel out these expansive effects for other banks. All
that is being analyzed here is the difference if any between what happens
in the case of successful bidding for Euro-dollars to offset CD attrition
and what happens in the case of unsuccessful bidding and consequent absence
of that offset.
2/ This assumes sale of liquid assets to nonbanks as the adjustment
route if bidding for Euro-dollars is unsuccessful. Borrowing at the
Federal Reserve discount window or borrowing Federal funds from a bank
with excess reserves or sale of liquid assets to a bank with excess
reserves would postpone the necessity of a sale of liquid assets to nonbanks.
is
FORD
GERALD
LIBRARY
To: Mr. Robert Solomon
- 5 -
The initial effects of CD attrition are to leave total credit un-
affected, and this is no more so and no less so if the banks losing
CD's offset their loss of liabilities by obtaining Euro-dollars.
5. To sum up, the one clear difference between what happens
when Euro-dollars are obtained to offset CD attrition and what happens
when CD attrition is not offset is that the impairment of the liquidity
position of the banks directly concerned is avoided if they get Euro-
dollars. To that extent, and for those banks, progress of the monetary
policy squeeze on bank liquidity, intended to bring changes in member
bank policies on investments and on loans, is delayed. However, if
Federal Reserve policy is influenced by what happens to total bank
credit, monetary policy may tend to become more restrictive shortly
after. Moreover, apart from Federal Reserve policy reactions, neither
the transmission of liquidity pressures through the U.S. banking system
nor the flow of total credit for U.S. residents is made any different
by the successful bidding for Euro-dollars, since getting the Euro-
dollars forces Treasury bill sales by foreign central banks in place
of asset liquidation by U.S. banks.
"Leakages" and other limits.
In the conventional theory of multiple expansion of bank
credit on the basis of an injection of deposits and reserves from out-
side the system, the process is described as one in which expansion of
To: Mr. Robert Solomon
- 6 -
loans and investments causes a spiraling growth of deposits, limited
by certain leakages:
(a) for the system as a whole the leakages are reserve
requirements and drain of currency into circulation;
(b) for individual banks or groups of banks, the leakages
are deposit withdrawals by their borrowers less
deposit acquisitions resulting from the expansion
process elsewhere in the system, plus net increase
in reserve requirements.
Consider now the Euro-dollar banking system. When it in-
creases its assets in the form of Euro-dollar loans it may possibly
experience some multiple expansion. But when the asset increase occurs
only in balances due from head offices, the leakage is 100 per cent.
No part of the funds loaned is redeposited by the head offices in Euro-
dollar banks.
Next, take the system consisting of the U.S. banking system
plus the Euro-dollar banking system. When U.S. banks obtain Euro-
dollars through their branches (as an alternative to selling Treasury
bills or other assets) this combined system increases its liabilities in
the form of Euro-dollar deposit liabilities and its assets in the form
of Treasury bills (as compared with what would otherwise have happened).
But the mechanics of the process require that the new supply of Treasury
bills come from foreign central banks, who do not add the dollars they
get to any deposits they may have either in the U.S. banking system or the
Euro-dollar banking system but rather sell those dollars. Again there
is a 100 per cent leakage. After the initial injection of deposits into
the Euro-dollar system no multiple expansion takes place.
FORD :- LIBRARY GERALD
To: Mr. Robert Solomon
- 7 -
The question then arises as to what limits there are
on the initial injections of deposits reloaned to head offices.
The limits on expansion of U.S. banks' liabilities to the Euro-
dollar market derive from (1) limits on the willingness of U.S. banks
to pay higher and higher interest rates; (2) the finite nature of
flows of new saving that might be expected to flow into Euro-dollar
deposits; and (3) the finite nature of the portfolios of persons
who may shift out of other assets to acquire Euro-dollars, and various
considerations affecting their willingness to shift.
These limitations did not prevent very large expansion of
liabilities to foreign branches at times when people were shifting
on a large scale out of sterling or French francs or German marks
into Euro-dollars. In February there was no flight out of sterling
or French francs, and the German and Italian central banks were
abstaining from providing their commercial banks with forward ex-
change cover at attractive rates -- while market rates for the forward
dollar against their currencies were at a discount -- and consequently
there was much less willingness to shift into Euro-dollars than there
had been at some earlier times.
FORD & GERALD LIBRARY
Chairman Burns
SPECIAL
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date February 3, 1970
To
Chairman Burns
Subject: Preliminary Balance of
From
Margaret Garber M.S.
Payments Indicators.
CONFIDENTIAL (FR)
Coverage of weekly indicators
Attached is a table showing weekly and monthly data on
settlement items in the U.S. balance of payments. The weekly data
on liabilities to foreigners are based on reports of the Federal
Reserve Bank of New York and on information obtained by the Bank
from large banks throughout the United States. Weekly data cover
liquid and nonliquid liabilities to foreign official institutions,
and liquid liabilities to international and regional organizations
and to commercial banks abroad, including foreign branches of U.S.
banks, as well as changes in U.S. reserve assets.
Liquid liabilities to other "private" foreigners are not
covered in this weekly series.
The monthly figures on liabilities to foreigners that are
used in the published accounts are based on reports to the Treasury
by all banks and banking institutions in the United States with
liabilities to foreigners of over $500,000. These monthly reports
give details by country and by type of liability.
The weekly indicators of settlement items in the balance
of payments essentially represent a sampling of the most important
GERALDO FORD LIBRARY
CONFIDENTIAL (FR)
-2-
elements of the liquidity and official settlements balances; the
coverage is incomplete, and because of the need for quick reporting,
errors are frequent and sometimes large. Nevertheless, with due
regard to the erratic behavior inherent in weekly data covering a highly
volatile phenomenon, these indicators serve reasonably well to suggest
tendencies in the over-all international accounts.
Liquid liabilities include demand deposits and time deposits
with original maturities of one year or less, other short-term (mainly
certificates of deposit, bankers' acceptances and commercial paper),
marketable U.S. Treasury securities and nonmarketable convertible U.S.
Treasury bonds and notes issued to foreign official institutions.
Nonliquid liabilities include foreign official time deposits
and CD's with original maturities of more than one year and nonmarketable
nonconvertible U.S. Treasury bonds and notes issued to foreign official
institutions.
U.S. reserve assets include the total U.S. gold stock, Treasury
and System holdings of convertible foreign currencies, reserve position
in the IMF and special drawing rights.
Recent changes in settlement items
In the week ended January 28, 1970 the balance of payments on
the liquidity basis showed a deficit of $164 million. There was very
little change in liabilities to foreign branches of U.S. banks and to
FORDO & LIBRARY GERALD
CONFIDENTIAL (FR)
-3-
other commercial banks abroad; liquid liabilities to foreign official
institutions increased $295 million while U.S. reserve assets increased
$115 million.
There was a deficit of $200 million on the official settlements
basis in the latest week. Liquid and nonliquid liabilities to foreign
official institutions rose $315 million, reflecting principally increases
in holdings at the New York Federal Reserve Bank of the United Kingdom
and Germany. The increase in U.S. reserve assets was related mainly to
a net increase of $102 million in holdings of foreign currencies through
a swap drawing of $200 million by Italy from the System and a swap
repayment of $100 million by the United Kingdom.
For the period January 1-28 there was a deficit of $1.8 billion
on the liquidity basis. However, this deficit was affected adversely
by the Treasury redemption of four mark-denominated Treasury notes,
totaling $500 million equivalent, issued to the German Federal Bank
under the second military offset agreement. Before this and other
special transactions, shown in the first column of the table, the
liquidity deficit amounted to $1.2 billion for the four week period.
The official settlements deficit for the same period amounted to $.5
billion.
All of the figures just mentioned for the January 1-28 period
exclude the initial allocation by the IMF to the United States of $867
FORD is LIBRARY GERALD
CONFIDENTIAL (FR)
-4-
million of SDR. With this increase in reserve assets taken into account
both of the over-all measures of balance would be more favorable.
Monthly data now available show that in December 1969 there
was a surplus of $2.7 billion on the liquidity basis. Liabilities to
foreign branches of U.S. banks and other private foreigners combined
declined $1.6 billion. On the other hand, U.S. reserve assets rose by
almost $1.0 billion, owing mainly to gold purchases from Germany ($500
million) and the Bank for International Settlements ($200 million) and
to purchases of dollars from the IMF by Germany and the United Kingdom
which increased the U.S. reserve position in the IMF. On the official
settlements basis there was a surplus of $1.1 billion in December.
For the year 1969 the liquidity deficit, as it will be
published about mid-February, was $6.7 billion or perhaps a bit higher.
In the year "special" transactions with foreign governments were adverse
to this balance by about $1 billion, as nonliquid claims on the United
States were reduced. Before these special transactions, the liquidity
deficit amounted to $5.7 billion. There was a surplus of $2.9 billion
on the official settlements basis for the year.
Attachment
FORD & LIBRARY 938870
CONFIDENTIAL--(F.R.)
Settlement Items in the United States Balance of Payments
(In millions of dollars)
Changes in
Changes in
U.S. Surplus (-
Selected U.S. Liabilities to Foreigners
U.S. Reserve Assets (signs reversed)
or Deficit (+
Nonliquid
Liquid
Reserve
Official
to private foreigners
Convertible
position
Special
trans-
Liquid
to official to official
foreign
foreign
in the
drawing
actions
ity
Period
foreigners
foreigners
branches
Other
total
Total
Gold
currencies
IMF
rights
Total
basis
basis
/
2
w
4
A
6
7
8
9
10
11
12
13
Week-
(3+4)
(2+5)
(1+2+11) (6+1
ended
1969-70
Dec. 24
- 10r
-453r
-184
70
-114
-567r
2
9
1
12
-451r
-555r
Dec. 31
--
-387
I
-1,398
256
-1,142
-1,529
-498
28
- 82
-552
-939
-2,081
Jan. 7
- 38
416
820r
-388r
432r
848r
- 28
125
1
98
476
946r
Jan. 14
-250
91r
521
- 34r
487r
3578r
6
-103
- 4
-23
-124
-283r
454r
141
Jan. 21
-269.7°
390p
390,54
-509p
331p
-178p
212p
--
76
- 18
- 2
56
140177p
197
268p
Jan. 28
20
295
- /
- 15
- 16
279
-
-1
-102
- 5
-7 - 7
-115
200
164
1969 Jam1-28
-538
991'l
1E8
-747
690
1,846
-23
- 4
- 26
- -32
- 85
533
1,761
Aug.
-173
1,060
194e
172e
366
1,426
- 10
-233
- 16
-259
628
1,167
Sept.
-178
1,436
-280e
- 72e
-352
1,084
- 10
-398
-140
-548
710
536
Oct.
-134p
175p
-349e
558e
209p
384p
- 26
456
- 3
427
468p
811p
Nov. P
- -45
- -677
-16 - 16
n.a.
n.a.
886
209
19
476
-179 -
316
=406
525
-
Dec. IQ II
-140
-1,563
-1,703
-688
84
- -360
-964
-1,120
-
2667
45
-1,707
2,821e
207e
3,028
1,321
56
- 72 -
- 32 32
- 48
-1,710
1,273
IIQ
-361
- 545
4,454e
176e
4,630
4,085
-317
245
-227
-299
-1,205
3,786
IIIQ
-512
2,244
1,135e
256e
1,391
3,6365
- 11
-441
-234
-686
1,046
2,949
IV PP
- 195
- 642
n.a.
n.a.
- 141.8
1,110
-695
1016
-542
-221
-
1,058
-1,331
YEARPI-1,023
- -650
n.a.
n.a.
8,581
7,931
967
748
-1,035
-1,254
-2,927
6,677
Note: The data for the week ended January 7 exclude changes in United States monetary reserves arising from the allocation
of Special Drawing Rights.
Changes in U.S. deposit liabilities to private nonbank foreigners reported by member banks are included in the monthly
but not in the weekly series. Changes in U.S. liabilities to international and regional nonmonetary organizations are
included in the monthly series as liabilities to private foreigners, but in the weekly a part unfortunately remains in
the "official" category.
e - estimates based on daily figures with somewhat incomplete coverage.
Balance of Payments Division
p - preliminary
Federal Reserve Bank of New York
r - revised
BERALD FORD LIBRARY
January 23, 1970
30,
Lc. 1970 or 1971]
PREFATORY NOTE
The two attached papers examine the effects on the U.S.
balance of trade of the excess demand and inflation that prevailed
in the United States in the second half of the 1960's. These two
independent studies come to the same general conclusion: had the
U.S. economy been held to a noninflationary high-employment growth
path after 1964, the United States would have had a substantial
trade surplus in 1969.
Mr. George Henry's paper simulates U.S. trade on the basis
of forecasting equations for exports and imports. Mr. Henry is an
economist in the Division's Special Studies Section.
The paper by Professor Adams and Mrs. Junz is based on
the OECD world trade model and examines the effects not only of
U.S. economic performance on trade flows but also the effects of
different assumptions regarding the economic performance of other
industrial countries. Professor Adams is on the faculty of the
University of Pennsylvania and is a consultant to the Board. Mrs.
Junz is a Senior Economist in the Europe and British Commonwealth
Section of the Division of International Finance.
Robert Solomon,
Adviser to the Board,
and Director,
Division of International Finance.
FORD is LIBRARY CERALD
United States Merchandise Trade, 1965-1969
by
George B. Henry
The period 1965-1969 witnessed a dramatic decline in the
United States' foreign balance on merchandise account. A surplus
for merchandise transactions (census basis, excluding military grant
shipments) of about $7 billion in 1964 was reduced to $0.8 billion
by 1968 ($1.3 billion in 1969). The severity of the decline has nec-
essarily become a matter of concern. However, it appears that a
crucial distinction for policy-making -- that between cyclical and
longer-run fundamental changes in the U.S. trade position -- has not
been adequately drawn. In particular, it is important to know to
what extent the trade deterioration can be attributed to the infla-
tionary conditions which prevailed in the United States during the
period in question. An estimate can be obtained by simulating trade
equations.
FORD i LIBRARY GERALD
- 2 -
This paper reports some simulations that have been generated
using forecasting equations. On the basis of these simulations, the
entire deterioration of the trade balance from 1964 to 1969 can be ex-
plained by the excess demand and price inflation that prevailed in the
United States during the period. The analysis implies that, had the
economy followed a non-inflationary, full-employment growth path, the
trade balance would not have weakened.
The paper is divided into two sections. Section I describes
the equations and the data employed in their estimation. Section II
provides a general summary and analysis of the simulation exercise.
I
The equations that are employed in this paper have variables
expressed in current dollars, having been expressly designed for short-
term forecasting. Thus they provide estimates of trade flows for any
period expressed in prices of that period and do not require companion
estimates of traded goods prices. The import equations are estimated
using data from the first quarter of 1955 to the fourth quarter of 1968.
1/ The form of the export equation was borrowed without modi-
fication from the work of Evelyn Parrish at the U.S. Department of
Commerce. The import equations are my own except that the GAP
variable was first used by Miss Parrish. In the near future the
Survey of Current Business will publish the latest results of her
work.
FORD & LIBRARY GERALD
- 3 -
They fit that data very well. The export equation is estimated
using data from the first quarter of 1958 to the fourth quarter of
1968 and is also quite respectable, although somewhat less reliable
than the import equations.
Before we describe the individual equations and the reason-
ing behind each independent variable, one general comment on method-
ology should be made. The essential characteristic of a forecasting
equation is that reasonably accurate estimates of its independent
variables be available for a year or more into the future. This
requirement inhibits disaggregation, that is, it inhibits forecast-
ing by commodity groups and/or geographical areas and typically
forces work to a very high level of aggregation, as in this paper.
It does more. One may desire a measure of the pressure on manufac-
turers' capacity, but settle for the much grosser concept of the GNP
gap; one may desire a variable for inventories of materials, yet
settle for all manufacturers' inventories; one may desire to estimate
using capital flows to particular areas of the world, yet settle for
2/ All such equations should be interpreted as applying to
experience within the limits of the sample. This caveat is more
important the less is the theoretical plausability of the equation,
since if we do not know the mechanism underlying the explanation,
we cannot be very confident of its applying under other circum-
stances. The equations used in this paper employ entirely rea-
sonable explanatory variables and exhibit reasonable elasticities.
The mean income elasticity of demand for imports is around 1.6;
the mean price elasticity is around 1.3.
FORD & GERALD LIBRARY
- 4 -
the total U.S. direct investment outflow. In general, one has to
compromise somewhat more on the selection of variables than if an
historical study were being undertaken. On the other hand, the re-
sultant equation must predict changes in the dependent variable
rather closely. So, while forecasting equations are by no means
uniquely suited for simulation exercises, they are not disqualified
either.
Imports
Table I presents the equations used in this paper. Table II
describes each variable and the data employed. The first equation
(Total Import Equation) is the best forecasting equation that I have
been able to develop. The equation predicts the seasonally adjusted
quarterly values of all U.S. imports except for imports of Canadian
automotive products. The U.S. .-Canadian agreement of 1965 vastly stim-
ulated trade of automotive goods in both directions; we eliminated
these items since their rapid growth has not depended on the course
of the general economy but on an exogenous factor, the negotiated
agreement,
The two most important factors affecting U.S. imports are
the level of U.S. national income and the relationship between foreign
3/ The remarks below apply with only minor modification to
equation II (Non-regulated Goods Import Equation) as well.
FORD & LIBRARY GERALD
- 5 -
Table I
Trade Equations
(t statistic in parentheses)
(I) "Total" Import Equation
M = -7.7223
+
0.0128 GNP
+
0.0146 RP
(27.256)
(1.850)
+
0.0499
USWPI
+
0.0062
GAP
(3.520)
(5.076)
-0.0087
I/O
+
0.0640
CIP
(1.954)
(2.251)
-0.0449 T
-0.2319 D
(11.360)
(4.372)
²² -2 R = .998
Durbin-Watson
= 1.74
Standard Error = $0.067 billion
Degrees of Freedom
=
47
LIBRARY GERALD ? FORD
- 6 -
Table I (continued)
Trade Equations
(t statistic in parentheses)
(II) Non-Regulated Goods Import Equation
NRM = -7.5589
+
0.0128
FS
+
0.0228
CBI
(28.490)
(6.414)
+
0.0263
RP
+
0.0214
USWPI
(3.664)
(2.021)
+
0.0040
GAP
+
0.0371
CIP
(2.805)
(1.341)
-0.0422 T
-0.1820 D
(11.110)
(3.526)
²² = .997
Durbin-Watson
= 1.76
Standard Error = $0.066 billion
Degrees of Freedom
=
47
FORD & GERALD LIBRARY
- 7 -
Table I (continued)
Trade Equations
(t statistic in parentheses)
(III) Export Equation
NX = 1.5070
+
0.0592
FIP
-0.0254
RPX_2
(6.787)
(2.575)
+
0.0036
FUTL_2
+
0.172 M-4
(2.611)
(3.819)
+
0.171
USDIO_3
-0.0491 T
(1.299)
(3.144)
2/R R = .992
_2
Durbin-Watson
= 1.93
Standard Error = $0.087 billion
Degrees of Freedom
=
37
FORD is GERALD LIBRARY
- 8 -
Table II
Definition of Variables
M
= U.S. imports in billions, quarterly, seasonally adjusted and
adjusted for strike distortions, excluding imports of automotive
products from Canada.
GNP
= Gross National Product in billions, seasonally adjusted annual rates.
RP
= U.S. wholesale price index for manufactures over weighted foreign
wholesale price index of manufactures, 1963 = 100.
USWPI = U.S. wholesale price index of manufactures, 1963 = 100.
GAP = [ (Actual real GNP/potential real GNP) - 0.97] 2 with appropriate
sign added.
I/O
= Ratio: (All manufacturers' inventories to orders) x 100.0.
CIP
= Dummy variable (=1.0 in quarter when change in industrial production
index [for all manufactures] becomes negative; = 0.0 elsewhere).
T
= Trend: 1,2,3, ... (1955-I = 1).
D
= Dummy for Mideast war of 1967: 1967-II = 1; 1967-III = 1; zero
elsewhere.
NRM
= U.S. imports in billions, quarterly, seasonally adjusted and
adjusted for strike distortions, excluding imports of automotive
products from Canada, and less imports of fuel and lubricants and
less imports of coffee, cocoa and sugar.
FS
= U.S. final sales (demand) in billions: GNP less changes in
business inventories (CBI), seasonally adjusted annual rates.
CBI
= Changes in business inventories in billions, seasonally adjusted
annual rates.
NX
= U.S. nonagricultural exports in billions, quarterly, seasonally
adjusted and adjusted for strike distortions. Data exclude ex-
ports of automotive products to Canada and exports of aircraft.
FIP
= Industrial production in Western Europe, Canada, and Japan,
weighted by U.S. exports, 1963 = 100.
RPX
= U.S. wholesale price index of manufactured goods over weighted
foreign wholesale price index of manufactures, 1963 = 100.
FUTL = Reciprocal of the weighted average of unused capacity in Western
Europe, Canada and Japan; thus, FUTL = 100/unused capacity.
USDIO = U.S. private foreign direct investment net outflow in billions,
quarterly.
LIBRARY GERALD FORD
- 9 -
prices and U.S. prices. The level of GNP (at seasonally adjusted,
annual rates) is our measure of national income. We expect that a
change in it will cause a change in imports in the same direction.
Table I indicates a coefficient for the GNP variable of +0.0128.
Since we are predicting quarterly imports with quarterly GNP ex-
pressed at annual rates, this implies that, if all other factors
remain unchanged, a $1 billion increase in GNP in any quarter (i.e.,
an annual rate of $4 billion) will result in approximately a $50 mil-
lion increase in U.S. imports in that quarter.
Two price variables enter the equation. The first, RP, is
simply the ratio of the domestic wholesale price index of manufactures
to a weighted average of foreign price indices. It measures relative
movements in prices; when U.S. prices are higher relative to foreign
prices, we expect imports to be greater. The coefficient of the RP
variable, +0.0146, indicates that for a one point increase in the
relative price of U.S. goods, some $15 million in additional U.S.
imports are induced. There is also entered separately the level of
U.S. wholesale prices (USWPI). Thus, for a given level of relative
prices, the higher are domestic prices, the greater will be the value
of imports. Since the dependent variable is in value terms, even if
the physical quantities demanded remained unchanged, a higher level
of world prices would increase the value of imports. Moreover, a
constant relative price, with widening absolute differential, may
FORD i GERALD LIBRARY
the 10 - -
well result in an increase in the quantity of imports. The coefficient
of the USWPI variable, +0.0499, indicates that for a one point increase
in the price of U.S. goods, some $50 million in additional U.S. imports
are induced,
Three cyclical variables, each serving a somewhat different
function, are included in the equation. The GAP is a proxy for the
pressure of demand in the United States (the variable is based on the
Council of Economic Advisors' calculation of the difference between
actual and potential GNP). The pressure of demand variable is assumed
to reflect changes in non-price competitiveness, i.e., changes in de-
livery lags, credit terms, quality of product and quality of after-
sales service, etc. Thus, an increase in the pressure of demand (i.e.,
adverse movements in the non-price "product characteristics") results
in an increase in U.S. imports. The coefficient of the GAP variable,
+0.0062, indicates that for a one point increase in the variable,
about $6 million in additional U.S. imports are induced. The vari-
able itself is a non-linear function of the gap, however. If, for
example, actual GNP moves from 94 per cent to 95 per cent of potential,
over $30 million in imports are induced.
Imports of materials can be expected to respond rather
quickly to changes in inventories of materials. Some materials are
not available domestically so that all changes in demand are reflected
in changes in imports. The movement of the inventory/order ratio (I/O)
FORD i GERALD LIBRARY
- 11 -
is an indicator of the relationship between desired and actual inven-
tories (on the assumption that some desired norm exists). Thus, we
expect the resultant negative relationship between imports and the
level of I/O. The coefficient of the I/O variable, -0.0087, indi-
cates that for a one per cent increase in inventories as a percentage
of orders, there is a $9 million reduction- in U.S. imports.
The change in industrial production variable (CIP) improves
the performance of the equation around turning points. It takes the
value 1.0 when industrial production initially turns down and is zero
elsewhere. In the first quarter that industrial production turns down,
imports tend to be greater than would be expected on other factors
alone by $64 million. It appears that the result is simply another
aspect of the "inflationary psychology" phenomenon. That is, busi-
nessmen have tended, at least recently, to be disbelieving about the
prospects for a downturn in the economy. Thus imports, which require
ordering some time before delivery, will be unusually high until the
fact of a downturn becomes inescapable.
The equation includes two additional dummy variables. The
trend dummy (T) assumes the value of 1.0 in the first quarter of 1955
and increases by one in each subsequent quarter. The coefficient of
-0.0449 indicates that if the level of GNP, prices, and everything else
remained absolutely the same from one quarter to the next, imports
would fall by some $45 million per quarter. One can devise
FORD is GERALD LIBRARY
- 12 -
explanations for this phenomenon. But in all honesty, the primary
justification is the much superior predictive ability of the equation
when the trend dummy is included. The final dummy variable (D) takes
the value of 1.0 in 1967-II and 1967-III and is zero elsewhere. It
purports to capture the unusual effects on imports of the Mideast war
of 1967. The coefficient of -0,2319 indicates that imports were re-
duced to $232 million below what they would otherwise have been in
each of the two periods.
The total result is a good forecasting equation for imports.
_2
The R is high (0.998), the Durbin-Watson statistic good (1.74) and
the t statistics are all acceptable (a 95 per cent significance level
is 2.02; a 99 per cent significance level is 2.69). The equation's
performance was excellent at turning points. There were five major
peaks of actual imports during the sample period. At four of these,
predicted imports peaked in the same period as actual imports. For
the last, predicted imports were virtually unchanged in the quarter
subsequent to the actual peak. For the conventional measure of the
equation's accuracy, we look at the standard error of the estimate,
about $67 million. Thus, a prediction by the equation will be within
$134 million of the actual value of quarterly imports ($4.4 billion,
on average, for the period of fit) about 95 per cent of the time.
Simulations are presented for two alternative import equa-
tions. The first (Total Import Equation) has been described in detail
FORD i LIBRARY GERALD
- 13 - -
above. The second (Non-Regulated Goods Import Equation) is similar
to the first except that it excludes imports of coffee, cocoa and
sugar, and fuels and lubricants, items whose entry to the United
States is restricted by quotas. To the extent that quotas are
effective, changes in United States economic activity and price
performance will not affect the amount of regulated goods imported.
Exports
The export equation predicts quarterly values of U.S.
exports of goods except for agricultural exports, automotive exports
to Canada, and exports of aircraft.
The most important factor affecting U.S. exports is the
level of foreign economic activity. A weighted average of foreign
industrial production indices (FIP) is our index of foreign activity
and is analogous to U.S. GNP in the import equation. Table I indi-
cates a coefficient for the FIP variable of +0.0592. This implies
that if all other factors remain unchanged, a one point increase in
FIP in any quarter will induce approximately $60 million in U.S.
exports.
The relative price variable is lagged two quarters with
the implication that foreign importers react to changes in relative
prices about six months after the fact. The coefficient of -0.0254
indicates that, for a one point increase in the relative price of
U.S. goods, there is a $25 million reduction in U.S. exports.
FORD & LIBRARY GERALD
- 14 -
The foreign utilization variable (FUTL) is a proxy for the
pressure of demand abroad and is analogous to the GAP variable in the
import equations. Thus, an increase in the pressure of demand abroad
(i.e., adverse movements in the non-price "product characteristics" of
foreign goods) results in an increase in U.S. exports. As with relative
prices, FUTL is estimated to have its impact on U.S. exports two quarters
after it changes. The coefficient of +0.0036 indicates that for a one
point increase in the variable, about $4 million in additional U.S. ex-
ports are induced. FUTL, however, is a non-linear function of the
utilization rate. If, for example, the foreign utilization rate moves
from 94 to 95 per cent of capacity, almost $12 million in U.S. exports
are induced.
The value of U.S. imports (M), lagged one year, is a proxy
variable for the availability of foreign exchange abroad. Its coef-
ficient of +0.172 indicates that a $1 million increase in U.S. imports
will result in a $172 thousand increase in U.S. exports four quarters
later.
The value of U.S. net direct investment outflow (USDIO) is
entered as a separate variable in the belief that U.S. exports are
intimately related to such investments. The coefficient of +0.171
indicates that a $1 million increase in the U.S. net direct invest-
ment outflow will result in a $171 thousand increase in U.S. exports
three quarters later.
FORD & LIBRARY GERALD
- 15 -
The equation includes a trend dummy variable (T) which as-
sumes the value of 1.0 in the first quarter of 1958 and increases by
one in each subsequent quarter. The coefficient of -0.0491 indicates
that if all else remained constant from one quarter to the next, ex-
ports would fall by some $49 million per quarter. As with the import
equation, the primary justification is the much superior predictive
ability of the equation when the trend dummy is included.
_2
The equation has an R of about 0.99 and a Durbin-Watson
statistic of 1.93. It does have one low t statistic. The standard
error of the estimate of $87 million implies that a prediction by the
equation will be within $174 million of the actual value of quarterly
exports ($4.3 billion, on average, for the period of fit) about 95 per
cent of the time.
II
One of the virtues of this simulation exercise is that its
procedures are readily understandable. Having estimated equations that
appear to capture the major forces affecting U.S. trade performance, we
simply make alternative hypothetical assumptions about the course of
the U.S. economy and permit the equations to generate alternative esti-
mates of what the U.S. trade performance would have been.
FORD i LIBRARY GERALD
- 16 - -
Assumptions
(1) Base Case; Inflationary, excessive real growth: All
independent variables are entered in the trade equations at their
actual values. The predicted values for imports and exports are the
base with which we will compare the equations' predictions under alter-
native assumptions.
(2) Assumption 1; Non-inflationary, full employment growth:
The foreign experience remains as it actually occurred. In general,
the U.S. economy is assumed to pursue a non-inflationary, full-
employment growth path from the second quarter of 1964 through 1969.
Specifically, U.S. GNP expands at a rate of 5-1/4 per cent per annum
from the third quarter of 1964. This reflects real growth of 3-3/4
per cent⁴/ and an increase in the GNP deflator of 1-1/2 per cent per
annum. Wholesale prices hold constant (as they did in the early 1960's).
(3) Assumption 2; Non-inflationary, excessive real growth:
In an attempt to derive an estimate of the impact of inflation, as con-
ceptually, if not always practically, separate from extraordinary real
growth rates, a substitute assumption has been introduced (this has
been employed only for the Total Import Equation, giving us a total
4/ This is a slightly conservative estimate of the real growth
potential of the nation. The Council of Economic Advisors estimates
that, around the beginning of 1966, real U.S. output potential began
expanding at a 4 per cent annual rate.
FORD is LIBRARY GERALD
- 17 -
of three simulations). Assumption 1 is modified by assuming real GNP
growth to be what it actually was in 1964-69, but with an increase in
the price deflator of only 1-1/2 per cent per year. In general, the
U.S. economy is assumed to pursue an excessive real, but non-inflationary,
growth path from the second quarter of 1964 through 1969. As a first
approximation, we may consider the improved trade balance under
Assumption 2 (relative to the Base Case) as the result of avoiding
price inflation. The trade deterioration which does occur under
Assumption 2 (relative to Assumption 1) might thus be considered the
consequence of excessive real growth.
Simulation Results
The results are displayed below in Tables III-V for the years
5/
1964-1969.
Column 1 (BASE) of each table gives the import results for
the base case. Column 2 (SIMUL.) gives the import results for the sim-
ulation of Assumption 1 or Assumption 2. Column 3 (B-SIM) is the dif-
ference between columns 1 and 2. Column 4 (Xˢ) is the simulation for
exports, consistent with Assumption 1 or 2, since it uses column 2 as
one of the inputs. Column 5 (XB) is the base case result for exports.
Column 6 (xˢ-xᵇ) is the difference between columns 4 and 5. Column 7
5/ For the purposes of the simulation exercise, the constant terms
of the equations have been adjusted to equalize actual and predicted
values for the full year 1964.
FORD i LIBRARY GERALD
LIBRARY
FORD &
Table III
GERALD
Non-Inflationary, Full Employment Growth
Total Import Equation
(1)
(2)
(3)
(4)
(5)
(6)
(7)
ATTRIBUTABLE
BASE
SIMUL.
B-SIM.
xˢ
XB
xˢ-xB
DETERIORATION
1964
18.5
18.4
0.1
18.1
18.1
0.0
0.1
18 I I
1965
20.9
19.3
1.6
19.3
19.2
0.1
1.7
1966
24.4
20.2
4.2
20.8
20.8
0.0
4.2
1967
25.4
21.0
4.4
21.5
21.7
-0.2
4.2
1968
29.7
22.7
7.0
23.4
23.5
-0.1
6.9
1969
33.0
24.0
9.0
26.5
26.7
-0.2
8.8
Table IV
FORD & LIBRARY GERALD
Non-Inflationary, Full Employment Growth
Non-Regulated Goods Import Equation
(1)
(2)
(3)
(4)
(5)
(6)
(7)
ATTRIBUTABLE
BASE
SIMUL.
B-SIM.
XS
xB
xˢ-xB
DETERIORATION
1964
18.5
18.3
0.2
18.1
18.1
0.0
0.2
19 I I
1965
20.9
19.1
1.8
19.3
19.2
0.1
1.9
1966
24.4
20.1
4.3
20.7
20.8
-0.1
4.2
1967
25.2
20.9
4.3
21.4
21.7
-0.3
4.1
1968
29.7
23.1
6.6
23.4
23.5
-0.1
6.5
1969
32.8
24.3
8.5
26.5
26.7
-0.2
8.3
Table V
FORD : LIBRARY GERALD
Excessive Real Growth Only
Total Import Equation
(1)
(2)
(3)
(4)
(5)
(6)
(7)
ATTRIBUTABLE
BASE
SIMUL.
B-SIM.
XS
XB
xˢ- X B
DETERIORATION
1964
18.5
18.4
0.1
18.1
18.1
0.0
0.1
20 I I
1965
20.9
20.3
0.6
19.3
19.2
0.1
0.7
1966
24.4
22.7
1.7
20.9
20.8
0.1
1.8
1967
25.4
22.8
2.6
21.9
21.7
0.2
2.8
1968
29.7
25.1
4.6
23.7
23.5
0.2
4.8
1969
33.0
25.8
7.2
26.9
26.7
0.2
7.4
- 21 -
(ATTRIBUTABLE DETERIORATION) is equal to the sum of columns 3 and 6,
and is the trade balance deterioration attributable to expansion in
the base case relative to the alternative.
The inflationary boom of 1965-1969 is seen to have been an
extremely important influence on U.S. merchandise trade during that
period (as may be seen in Tables III and IV). Inflation and exces-
sive real growth are estimated to have impared the annual trade
balance by $6.5-6.9 billion by 1968. Contributing to the total,
imports were $6.6-7.0 billion greater in 1968 under the base case
than they would have been under Assumption 1. This import deteri-
oration was slightly offset by induced exports of $100 million.
The lower ends of these estimates are based on the assumption that
trade restrictions render certain categories of U.S. imports inde-
pendent of general economic activity (Table IV).
The actual deterioration in the balance between 1964 and
1968 was just under $6.0 billion, having fallen from a deficit of
$400 million to a deficit of $6.4 billion. Thus the simulations
6/ The results are included for 1969, but are not very helpful.
All sets of equations predict a further move toward deficit, when in
fact, a small improvement occurred in the balance on these items. This
results in large measure from the inability of the export equation to
predict exports at a cyclical peak, partially because of the absence of
cyclical explanatory variables. The equation was well off in predict-
ing exports for 1969, although it had done tolerably well until that point.
11 Recall that we have reference to the balance of "non-agricultural
exports less exports of aircraft and automotive products to Canada" and
"imports less automotive imports from Canada".
FORD is LIBRARY GERALD
- 22 -
indicate that if growth had proceeded as in Assumption 1, the U.S.
merchandise trade balance would not have weakened.
Our estimates for the separate effects of excessive real
and price growth can be seen in simulation Tables III and V. In
1968, the total deterioration attributable to inflation and excess
real growth (Table III) is $6.9 billion. Had only the excess real
growth occurred (Table V), the deterioration would have been $4.8
billion. Thus, some $2.1 billion might be referred to as the
"price effect"
Special Features of the Results
(1) The equations seem reliable. Comparisons have been
drawn throughout between what the equations predicted under actual
circumstances and what the equations predicted under alternative
assumptions. But, in fact, the import equation predictions have
been very close to the actual results. Indeed, the average error
in predicting 1969 quarterly imports (i.e., four quarters beyond
3/ We can compare the earlier period, 1960-1964, when the
growth in nominal GNP was between 5 and 5-1/2 per cent per annum.
The U.S. wholesale price index was virtually unchanged and the
weighted foreign price index rose some 6 per cent in total (as it
did from 1964-1968). The balance, defined the same way, improved
by 700 million from 1960-1964. Of course, in the early 1960's, a
sizable gap existed between potential and actual GNP.
9/ These are crude guesses. Excessive real growth and infla-
tion are related. Moreover, the import equations do not explicitly
distinguish between changes in real GNP and movements in the GNP
deflator.
FORD i GERALD LIBRARY
- 23 -
the sample period) was only about $30 million or less than 1/2 of 1 per
cent. This inspires some confidence that we are doing more than simu-
lating an arbitrary set of equations. These equations capture the
actual movements of trade flows tolerably well. On the other side of
the coin, it should be noted that the export equation does not perform
nearly so well outside the sample period. The average underestimate of
quarterly exports in 1969 was some $200 million, or a little over 3 per
cent. As noted in footnote 6, this has introduced error into the simu-
lations for 1969.
(2) There are no lags in the import equations. A burst of
inflation and rapid growth in GNP in 1965-1966 resulted in very rapid
increases in imports. The relative slowdown in 1967 quickly halted
the deterioration in the balance of trade. Exports are predicted more
accurately, however, with most variables lagged two or more quarters.
(3) Finally, the trade deterioration caused by inflation
has been on the import side. In fact, U.S. exports are found to de-
pend in small part on prior levels of U.S. imports. After a short
time, U.S. exports are thus stimulated by "excessive imports". Our
simulations indicate that this stimulatory effect more than offsets
the direct impact of the decline in price competitiveness on our ex-
ports, though to be entirely convincing, the result would have to be
tested further.
FORD & LIBRARY GERALD
- 24 -
Qualifications and Conclusion
Several qualifications must be offered with the results.
(1) The standard errors of the equation coefficients have been
ignored. Thus, the numbers generated in the simulation exercise
are properly viewed as the midpoints of confidence intervals.
(2) There is only one interrelationship between the U.S. economy
and the rest of the world in the equations, i.e., U.S. imports
induce U.S. exports with a lag. In fact, there are many others.
For example, price increases abroad may have been "exported" by
the United States. A 25 per cent variation in the dollar value
of U.S. imports would surely have had some effect on foreign in-
dustrial production. Had the United States not expanded so rapidly,
other countries might have taken steps to stimulate their exports
and reduce their imports. Accounting for any of these factors would
tend to reduce the trade balance deterioration attributed to our rate
of expansion. (3) The results follow from the assumptions about the
course of economic activity here and abroad. Different assumptions
will yield different results. In particular, it is worth reiterating
that a somewhat conservative annual growth rate for U.S. potential
real output (3-3/4 per cent) has been assumed. 10/
10/ Had a 4 per cent growth rate been assumed, the trade balance
deterioration attributable to inflation and excessive real growth would
be reduced by about $500 million (to a range of $6.0-6.4 billion).
FORD & LIBRARY 938470
- 25 -
Despite these qualifications, the results are revealing. They
caution against policy prescriptions based on the assumption that struc-
tural or fundamental changes in U.S. competitiveness have occurred.
Instead, they argue for the efficacy of sensible U.S. demand management
in achieving an adequate balance on merchandise trade.
FORD & GERALD LIBRARY
ALORA ALLD R. FORD LIBR
Preliminary
A Note on the Effect of the 1965-69 Boom in
the United States on World Trade
by
F. Gerard Adams and Helen B. Junz
The U.S. trade surplus, which had run at a healthy $5 billion
annual rate in the early 1960's, declined sharply after the middle of
the decade until mid-1969, by which time it had eroded to virtually
nothing. The magnitude of this decline has necessarily raised questions
about the underlying causes and about the future trend of the U.S. trade
balance. Basically, the questions regarding causality are aimed at
determining whether a fundamental and structural shift has occurred in
the U.S. competitive position in world markets or whether the severe
deterioration in the trade position is temporary -- and particularly
cyclical -- in nature. The answer to this question has obvious policy impli-
cations. Specifically, this note addresses itself to the question of the
effect of inadequate demand management policies -- here and abroad -- upon
trade flows, utilizing a simple application of an updated version of the OECD
world trade mode11/ to put quantitative dimensions on this effect. The
F. G. Adams, H. Eguchi and F. Meyer-zu-Schlochtern,
An Econometric Analysis of International Trade, OECD, Paris, 1969.
LISBARY GERALD R. FORD
- 2 -
model, which was designed to isolate pressure of demand and price
effects from other influences upon trade flows, is a good vehicle for
such calculations. Like all such models though, it can indicate only
the approximate range of magnitudes involved. Within this limitation,
the model has been used to contrast a base solution -- which assumes
that economic activity and prices moved as they actually did throughout
the period -- with alternative solutions postulating first, what would
have happened if instead of moving above its potential growth path, the
U.S. economy had grown at its potential rate after 1964, and, second,
what would have happened if other industrial countries had kept their
economies fully employed throughout the period.
The results of these comparisons show that the inflationary
boom that gripped the United States after 1964 had a very considerable
impact upon trade flows. It reduced the U.S. trade surplus markedly
and it augmented the surpluses of Japan and, though less substantially,
those of European countries, notably Germany and Italy. If the U.S.
economy had followed a non-inflationary growth path from 1965 onward --
that is if real GNP had grown about in line with the underlying growth
rate of productive capacity -- the U.S. trade balance in the first half
of 1969 would have been at least $3-1/2 billion larger than it was in fact.
This result is based on the assumption that Canadian economic
activity would also have grown at a slower rate, but that the economies
of the rest of the world would have developed as they actually did.
GERALD R. FORD LIBRAPA
- 3 -
Given the historically close inter-relationship between economic activity
in the United States and Canada, it is only reasonable to assume that
Canadian demand management policies could not have fully offset the
effects of significantly slower growth of U.S. demand. Furthermore, the
Canadian authorities probably would not have been inclined to adopt such
policies consistently since Canada, during a major part of the 1965-69
period, was trying to reduce inflationary pressures.
For the other industrial countries, however, it is not
unreasonable to assume that economic activity could have proceeded along
actual trends. In fact, a number of European countries experienced a
considerable amount of slack during some part of the simulation period,
notably Germany, France and Belgium in 1966-early 1968 and Italy during
most of the period. It was only during 1969 that these economies began
to experience supply constraints. Therefore, a further question was
asked, namely, how trade flows would have been affected if the industrial
countries outside North America had adopted demand management policies
so as to keep their economies fully employed, at the same pressure of
demand as they experienced in the second half of 1964, while the United
States and Canada grew at non-inflationary rates. The results of this
simulation yield an improvement in the U.S. trade balance in the first
half of 1969 of just over $6 billion.
The study thus suggests that if the United States avoids
excess demand, the U.S. trade balance can benefit considerably. If
LIBRARY GERALD R. FORD
- 4 -
other industrial countries, at the same time, act upon their commitment
to high- employment goals, the improvement in the U.S. trade position
could be even greater. This conclusion is supported by the recent
improvement in the U.S. trade surplus, which in May-July 1970, has run
at an annual rate of $4-1/2 billion. However, this level has been
achieved at U.S. activity rates well below capacity, while many other
countries are experiencing rather higher rates of demand pressure than
they wish to see. Thus the "full employment trade surplus" of the United
States may be less than the actual trade surplus now, but the trade balance
still shows a rising trend. It is difficult to predict to what extent
the effects of the past years of inflation -- in terms of lost market
opportunities -- can be rolled back. But, given the responsiveness of
trade flows to alternative economic conditions, the world cyclical
constellation currently offers a better than average possibility of
recouping lost ground, if U.S. demand management policies are successful
in preventing excess demand, while the economy returns to an adequate
growth path.
The Updated OECD Trade Model
The updated version of the OECD trade model used in these
calculations was prepared by Mr. Yajima at OECD in Paris during 1969.2/
2/ The authors wish to thank Mr. Yajima for providing the card deck
and for his assistance in adapting it to the present purpose.
FORD & GERALD LIBRARY
- 5 -
While it maintains the character of the original OECD trade model
it has been reestimated on data for the period 1955 to 1968 and it has
undergone some structural modifications. The basic model consists of
a set of import and export equations. These equations, shown for the
updated version in Appendix Table I, form an interrelated system.
Imports are predicted for each country -- the countries are the seven
most important OECD countries, other OECD as a group, and non-OECD also
as a group -- on the basis of economic activity variables such as indus-
trial production or GNP, pressure of demand, and relative prices. The
pressure of demand effect (PD) is measured by the ratio of actual indus-
trial production to its semi-log trend value. This serves as a simple,
but useful, measure of business cycle position and avoids dealing with
uncertain data on such variables as unemployment or inventory change.
Pressure of demand has been introduced non-linearly in some cases by
including only values when industrial production is above trend (PD+).
Imports of the non-OECD countries, principally developing countries, are
a function of their exports (lagged), capital inflows, and reserve changes.
Estimated imports then enter into the export equations in the
form of an import market variable (S), which represents the exports which
each country would have if its trade share in world markets remained at
its base year (1963) level, Relative prices and relative pressure of
3/ Adams et al., op. cit.
GERALD R. FORD
- 6 -
demand are the other principal factors determining each country's
exports. Total estimated exports are adjusted to equal total imports,
but the adjustment required represents only a small percentage of the
total. The model does not include feedbacks from the trade balance to
economic activity or prices. This is appropriate here since our simula-
tions assume that each country uses available policy instruments to
achieve stipulated economic conditions in the domestic economy.
The specification of the updated model differs from the original
in certain respects. The updated model has been estimated entirely in
log-log form, on semiannual data. Pressure of demand has been measured
by establishing the level of industrial production relative to a semi-log
trend of industrial production. In the case of the United States and
Canada, GNP has been used as the activity variable rather than industrial
production. With regard to import prices, the model has been refined to
measure import prices as a weighted average of the export prices of the
supplier countries. This average is deflated by the GNP deflator of the
importing country. A number of dummy variables have been introduced to
allow for special circumstances such as strikes and data aberrations.
The data have been adjusted to eliminate the impact of the U.S./Canadian
Auto Agreement. The elasticities of exports with respect to the import
market variable (S) have been determined empirically by regression in
the updated version of the OECD model,
4/ They had been constrained to equal 1.0 in the earlier version of the
OECD model.
FORD : LIBRARY GERALD
-7-
OECD Trade Model Simulation of Non-In-
flationary Growth in the United States
Simulations of the OECD trade model involved estimation of a
base case, using the values of the exogenous variables as they actually
occurred, and alternative solutions, substituting different values based
on assumptions of moderate non-inflationary growth in the
United States and Canada and/or more rapid expansion of activity and
prices in other industrial countries. The simulations cover the period
1964 to mid-1969. The equation constants were adjusted to equalize the
estimated values and the actual values of imports and exports in each
country over the average of the year 1964 in order to provide an appro-
priate starting point for the simulations.
The results of the base case simulations, when compared with
the actual values, show that the model generally tracks the actual
movements that occurred, though aberrations in the measure of pressure
of demand (PD) and prices occasionally obscure short-term movements. But
these occasional deviations of estimated values from actual movements do
not impose real limitations upon the simulation results. The basic
assumption in the simulation calculations is that estimation errors in
the simulation with actual values -- the base case simulation -- carry
over also to the simulations with postulated values. The effect of the
variation in economic conditions on trade flows is then measured by the
difference between the base case simulation and those with assumed values.
Thus estimating errors reflecting short-term deviations of simulated
values from actual movements are eliminated and the derived effects can
GERALD
FORD LIBRARY
-8-
be taken to denote the difference between actual trade flows and those
that would have occurred under different economic conditions.
Simulation Assumptions
The following simulation cases were considered:
Base Case:
The base case introduces all exogenous variables at their actual
values during the sample period.
Alternative Case I: Moderate non-inflationary growth
in the United States.
The statistics on economic growth and inflation in the United
States show a fairly clear break between 1964 and 1965, which saw the
beginning of rapid economic expansion and acceleration of the rate of
price increase. It was assumed, consequently, that beginning in the first
half of 1965, the U.S. economy expands at a rate corresponding to that
for potential real GNP (using the Council of Economic Advisors' estimate
for the mid-1960's of an annual rate of expansion of 3.75 per cent) -- and
that the GNP deflator and export prices increase at the rate of 1.5 per
cent p.a. as in the early 1960's. By the first half of 1969 this results
in GNP approximately 4 per cent and in prices 7.7 per cent below actual
levels. Alternative calculations assuming a 4 per cent growth rate for
GNP (the CEA's estimate of the annual potential rate of growth for 1966-69)
yield a first half 1969 level about 3 per cent below actual. Elimination
of cyclical throughs and peaks during the 1965- mid-1970 period would
have yielded levels of output very close to those that actually occurred.
FORD i 07V839 LIBRARY
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Steady growth of real GNP at a 3-3/4 per cent or a 4 per cent annual
rate would have resulted in a first half 1970 GNP level just below or
just above actual, respectively.
Alternative Case Ia: Moderate non-inflationary growth
in Canada as well as in the United States.
While the present model lacks feedback features, it is clear
that economic expansion in Canada is greatly dependent on developments in
the United States. Consequently, in addition to the assumption of
moderate growth in the United States, it was thought appropriate also
to assume slower growth and smaller price increases in Canada. There-
fore, it was assumed that Canadian GNP would have expanded at an annual
rate of 4.5 per cent beginning with the first half of 1965 and that the
rate of price increase would have been 1.5 per cent p.a. as in the
United States. By the first half of 1969 the assumed real GNP and the
corresponding GNP deflator would have been 3 per cent and 8-1/4 per cent,
respectively, below actual levels.
Alternative Case II: More rapid expansion and
price increase in other industrial countries.
In many of the major industrial countries outside the United
States and Canada, economic activity expanded at a slower pace after
1964 than in preceding years and a sharp upward surge of activity and
prices did not occur until 1968. In fact, Germany experienced a
recession in 1966-67 and France, Italy and Japan, all at some time
during the period had under-utilized resources. The United Kingdom
pursued stringent stabilization policies during a major part of the
period. In order to test how much this non-concordance of cyclical
GERALD R. FORD LIBRARY
-10-
paths contributed to trade developments, in this simulation it is assumed
that growth was such as to maintain the 1964 level of resource utilization
and that prices continued to increase at about the same rate as was
recorded from the second half of 1963 to the end of 1964. The specific
assumptions about economic growth and rates of inflation for the major
industrial countries other than the United States and Canada are as follows: 5/
France Germany Italy U.K. Japan
Assumptions Alternative Case II
GNP deflator, % change p.a.
4.0
3.0
7.0
5.0
5.0
Export prices, % change p.a.
4.0
4.0
2.0
3.0
0
Position in first half 1969a /
Index numbers, 1963 = 100
Industrial production, actual
140
142
144
123
212
assumed
138
141
147
123
214
GNP deflator, actual
124
117
123
104
128
assumed
126
119
147
110
129
Export prices, actual
111
109
100
107
103
assumed
124
124
111
99
102
Price changes adjusted for exchange rate changes.
In general, the growth assumptions lead to levels of output
and cyclical positions in the first half of 1969 that are rather similar
to those which actually prevailed. But price levels are higher because
5/ In this simulation it was assumed that there is no feedback so
that activity in the United States and Canada were taken at their actual
levels. It should be noted that imports, exports, and prices in the
United States and Canada are affected insofar as they depend on relative
prices or pressures of demand.
FORD i LIBRARY GERALD
-11-
elimination of cyclical throughs resulted on average in higher pressure
of demand after 1964 than actually occurred. While it is questionable,
at least in some cases, whether these relatively high pressures of
demand could have been sustained throughout the period, the assumptions
underlying this simulation either approximate quite reasonably or under-
state the cyclical positions actually prevailing in the first half of
1970. For example, the rates of inflation, as measured by the GNP deflator,
in the first half of this year were as follows:
France 5-3/4 per cent, Germany 7-1/2 per cent, Italy 6-3/4 per
cent, United Kingdom 5-1/2 per cent, Japan 6-1/2 per cent.
In all cases, except Italy, this was above the rates assumed
for the simulations. Pressure of demand in France, Germany, and Japan
was higher than in 1964 and in the United Kingdom and Italy it was about
the same. In further work it might be interesting to test additional
alternatives which would attempt to approximate a more realistic growth
path for each of these countries. This would involve postulating different
and changing values for the economic growth and prices variables of each
country. The more global assumptions chosen for the present study suffice
here, because it addresses the general question of the effect on trade
flows of alternative rates and combinations of economic activity in major
industrial countries.
Alternative Case III: Moderate non-inflationary growth in the
United States and more rapid expansion and price increase in
other industrial countries.
This case corresponds to a combination of Alternative Cases I
and II.
FORD & LIBRARY GERALD
6/ Canada is taken at its actual levels.
-12-
Alternative Case IIIa: Moderate non-inflationary growth in Canada as
well as in the United States and more rapid expansion and price
increase in other industrial countries.
This is a combination of Alternative Cases Ia and II.
Simulation Results for Non-Inflationary
Growth in the United States
Taking the United States first, simulations I and Ia show
that slower economic expansion combined with a very moderate rate of
price increase would have resulted in substantially lower imports and
somewhat increased exports (see tables 1 and 2) In case I, where
activity rates were changed only in the United States, the U.S. trade
balance in the first half of 1969 would have been $4.5 billion higher
than it actually was. In case Ia, it is rather more realistically
assumed that lower activity rates in the United States should be combined
with slower growth in Canada also. Constraining the expansion of the
Canadian market results by the first half of 1969 in a $1 billion lower
export improvement for the United States and the improvement in the
U.S. trade balance, in this case, is $3.5 billion.
The impact of more rapid expansion in the other industrial
countries (case II) on U.S. imports occurs through the relative price
term. While in this case U.S. imports would have been lower than estimated
in the base case for the entire period 1965 through 1968, the import
71 As noted on page 7 comparisons should be made between the base
case and the alternatives, This is particularly important for the 1967
period, because the U.S. equation did not catch the temporary slowdown
of U.S. imports at that time.
FORD & LIBRARY GERALD
-13-
Table 1. Effect on U.S. trade of moderate non-inflationary growth
in the U.S. (Case I)
(billions of 1963 and current $, seasonally adjusted,
annual rates)
Change from actual:
Exports
Imports
Trade Balance
Trade Balance
1963 dollars
current dollars
1965 I
+.0
- .4
+.5
-.4
II
+.2
-1.1
+1.4
+1.4
66 I
+.2
-1.8
+2.0
+2.1
II
+.9
-2.0
+2.9
+3.0
67 I
+.4
-1.6
+2.1
+2.2
II
+.9
-1.8
+2.6
+2.8
68 I
+.9
-2.3
+3.3
+3.5
II
+1.1
-2.8
+3.9
+4.3
69 I
+1.4
-2.8
+4.1
+4.5
Totals may not add due to rounding.
GERALD FORD LIBRARY
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Table 2. Effect on U.S. trade of moderate non-inflationary growth
in the U.S. and Canada (Case Ia)
(billions of 1963 and current $, seasonally adjusted,
annual rates)
Change from actual:
Exports
Imports
Trade Balance
Trade Balance
1963 dollars
current dollars
1965 I
- .1
- .4
+.4
+.4
II
- .0
-1.1
+1.1
+1.1
66 I
- .3
-1.8
+1.5
+1.6
II
+.2
-2.0
+2.2
+2.3
67 I
- .1
-1.6
+1.5
+1.6
II
+.3
-1.8
+2.1
+2.2
68 I
+.3
-2.3
+2.6
+2.9
II
+.3
-2.8
+3.1
+3.4
69 I
+.4
-2.8
+3.2
+3.5
Totals may not add due to rounding.
GERALD R. FORD LIBRARA
R.
FORD
GERALD
LISBARY
-15-
estimate for the first half of 1969 obtained by simulation II corresponds
to the result of the base case. U.S. exports, on the other hand, would
have been substantially higher throughout the entire period.
Finally the two assumptions -- slower growth in North America
and faster growth elsewhere -- are put together in simulations III and
IIIa and the results show that the two effects are cumulative (see Table 3).
If the United States and Canada were growing more slowly and other countries
more rapidly, the impact on U.S. imports is to produce a smooth path (a
reflection of the smooth path of activity and prices assumed in the
simulations) substantially below the results of Simulation Ia (non-
inflationary growth in North America). By the first half of 1969, however,
when other industrial countries were approaching similar cyclical positions
in the simulations as in actuality, U.S. imports in simulation IIIa begin
to approximate those obtained in simulation Ia. The impact on U.S. exports
of more rapid economic expansion and higher rates of inflation in industrial
countries other than Canada is pronounced. The balance of trade impact
of simulation IIIa rises to between $5 and $6 billion (1963 dollars)
from the second half of 1967. In the first half of 1969 it amounts to
$5.6 billion in 1963 dollars and $6.1 billion in current dollars.
With regard to Canada, where activity and prices in the simula-
tions are assumed to move parallel to those in the United States economy,
the impact is also comparable. Though the balance of trade impact is
similar to that for the United States, it is of course smaller in absolute
magnitude. Thus, simulations Ia and IIIa yield an improvement in the
Canadian trade balance of up to $1.5 billion (1963 dollars) and $2 billion
-16-
Table 3. Effect on trade flows of slower rates of growth in U.S. and Canada
combined with higher rates in other industrial countries (Case IIIa)
(billions of 1963 $, seasonally adjusted, annual rates)
A. Exports
Change from actual:
U.S.
Canada
France
Germany
Italy
U.K.
Japan
Other OECD
Non OECD
1965 I
+.3
+.0
+.0
+.4
.0
+.1
-.1
+.2
+.4
II
+.8
- .1
-.2
+.3
- .3
+.2
-.3
+.3
+.2
66 I
+.5
- .3
+.1
+.1
-.3
+.2
- .8
+.3
+.0
II
+1.2
- .2
+.0
- .4
- .3
+.2
-.7
+.7
+.0
67 I
+1.2
- .0
+.3
- .4
- .1
+.3
-.5
+1.5
+.8
II
+2.0
- .1
- .2
- .7
- .4
+.3
- .5
+1.5
+.5
68 I
+2.4
+.2
- .6
- .9
- .4
+.0
- .3
+1.6
+.6
II
+2.6
+.1
- .8
-1.9
-1.4
- .1
..6
+.5
- .6
69 I
+2.5
+.2
- .9
-2.6
-1.5
- .3
-.6
-.3
-.7
GERALD
R.
FORD
LIBRARY
- 17 - -
Table 3. (continued)
B. Imports
Change from actual:
U.S.
Canada
France
Germany
Italy
U.K.
Japan
Other OECD
Non OECD
1965
I
-.4
-.2
+.9
-.3
+.8
-.0
+.6
0
-.0
II
-1.4
.4
+.7
+.2
+.7
+.0
+.9
+.2
66
I
-2.3
-.9
+.8
+.2
+.9
-.0 -
+.9
By
+.1
II
-2.4
-.8
+.7
+1.3
+.9
+.5
+.4
def-
- -.1
67
I
-2.4
-1.0
+1.2
+2.6
+.9
+1.0
+.7
ini-
- .0
II
-3.0
- -.9
+1.2
+2.3
+1.2
+.9
+.4
tion
+.3
68
I
-3.4
-1.1
+2.0
+2.0
+1.9
+.7
+.5
+.1
II
-4.1
-1.4
-.6
+.9
+2.1
+.5
+.2
+.2
69
I
-3.1
-1.7
-1.5
- .2
+2.1
-.0
+.6
0
-.4
FORD & LIBRARY
- 18 - -
Table 3. (continued)
C. Trade Balance
Change from actual:
U.S.
Canada
France
Germany
Italy
U.K.
Japan
Other OECD
Non OECD
1965
I
+.7
+.2
#.9
+.8
-.8
+1
-.7
+.2
+.5
II
+2.2
+.3
-0.9
+.2
-1.0
+.1
-1.3
+.3
+.0
66
I
+2.8
H.6
-0.8
-%1
-1.2
+.2
-1.6
+.3
-.1
II
+3.6
+.6
-.7
-1.7
-1.2
-.3
-1.1
+.7
+.1
67
I
+3.6
+.9
-1.9
-3.0
-1.0
-.7
-1.2
+1.5
t.8
II
+5.0
+.8
-1.4
-3.0
-1.6
-.7
- .8
+1.5
+.2
68
I
+5.9
+1.3
-2.6
-2.9
-2.1
-.7
-.8
+1.6
+.5
II
+6.7
+1.5
- -.2
-2.7
-3.5
-.7
-1.8
+1.5
-.7
69
I
+5.6
+1.9
+1.6
-2.4
-3.6
-.3
-1.3
-0.3
-.2
FORD is LIBRARY
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(1963 dollars) per annum, respectively. This is remarkably close to the
improvement actually registered in the first half of 1970 when the
cyclical constellation was quite similar to that assumed in simulation IIIa,
though the U.S. rate of inflation was rather higher and pressure of
demand in the United States rather lower than assumed.
The impact on other countries of the postulated economic
developments in the United States and Canada (simulations I and Ia)
varies (see Table 4). The effect is most pronounced on the exports of
Japan and the Japanese trade balance deteriorates by up to $2 billion
(1963 dollars) per annum, For all other countries the effect is much
smaller ranging from a maximal annual loss of $3/4 billion for Germany
to $1/4 billion for the United Kingdom (both 1963 dollars). These results
would support the conclusion that the exchange rate adjustments which took
place in 1968 and 1969 reflected adjustments to structural imbalances
that were independent of U.S. cyclical developments in 1965-1969.
Since simulations II and IIIa assume steady high rates of growth
and accelerated price increases in the industrial countries other than
the United States and Canada, it is not surprising that the main impact
is concentrated on the imports of these countries. It is interesting
to note, however, that the assumptions used are such as to smooth out
GERALD FORD LIBRARY
the path of imports so that the level of imports reached by the first
half of 1969 under the simulation II and IIIa assumptions is not very
different from that in the base case. Since utilization of resources
in Italy has been rather lower than in other industrial countries in
recent years, the simulation assumptions make a more significant difference
-20-
Table 4. Effect on trade balances of non-inflationary growth in North America (Case Ia)
(billions of 1963 $, seasonally adjusted, annual rates)
Change from actual:
U.S.- 1/
Canada
France
Germany
Italy
U.K.
Japan
Other OECD
Non OECD
1965 I
+.4
+.2
+.0
-.0
-.0
-.0
- .2
-.0
-.1
II
+1.1
+.2
-.1
-.1
-.1
-.1
- .4
-.1
-.4
1966 I
+1.5
+.5
-.1
-.2
-.2
-.1
-.8
-.2
-.3
II
+2.2
+.5
-.3
-.3
-.2
-.2
-.9
-.3
-.5
1967 I
+1.5
+.8
-.2
-.4
-.2
-.2
- .9
-.2
-.1
II
+2.1
+.7
-.3
-.4
-.2
-.2
-1.0
-.3
-.3
1968 I
+2.6
+1.0
-.4
-.5
-.3
-.2
-1.3
-.3
-.5
II
+3.1
+1.2
-.5
-.6
-.4
-.2
-1.7
-.4
-.4
1969 I
+3.2
+1.5
-.6
-.7
-.5
-.3
-1.9
-.4
-.4
1/ An indication of the impact of alternative assumptions is obtained by assuming in case Ia that the
U.S. grows at 4.0 per cent in place of 3.75 per cent. The figures would be for the U.S.:
65I +.4
67I
+1.4
65II +1.0
67II
+1.8
66I
+1.2
68I +2.4
66II +2.0
68II +2.8
69I +2.6
7188484 GERALD FORD
-21-
in this case than in others. Particularly the assumed rate of inflation
is from a balance of payments point of view unsustainably high. However,
recent developments seem to bear out the reasonableness of the
general simulation results. The combination of slower expansion in the
United States and Canada and more rapid expansion in Europe and Japan
results in substantial balance of trade deterioration spread among the
major continental European countries (see Table 3). The change, as stated
above, is largest for Italy. The German trade balance is less favorable
by an annual rate of between $2 and $3 billion (1963 dollars). The
highest impact is registered in 1967 and in the first half of 1968, since
economic activity in Germany was well below potential during that period.
The impact on France, $1 to $2.6 billion (1963 dollars) p.a., is also
greatest during the second half of 1968, when actual inflationary pressures
began to equal those assumed in simulation IIIa. Perhaps one of the
more interesting effects is that more rapid growth of activity and prices
in European countries substantially improves the trade balance of Japan
(compare simulation IIIa with simulation Ia) despite the assumption of
somewhat higher growth and inflation in Japan itself.
Alternative Pressure of Demand Simulations
In order to appraise better the role of varying degrees of
pressure of demand and corresponding price trends, an additional set of
simulations has been carried out assuming alternative values -- ranging
from boom conditions to economic slack -- for pressure of demand and prices
for the U.S. economy over the period from the end of 1964 to the first
FORD i GERALD LIBRARY
-22-
half of 1969. To carry out these calculations it was necessary to modify
the OECD model to substitute import equations using industrial production
and activity variables for the United States and Canada. The change also
includes a new treatment of import prices, linking import prices to the
weighted export prices of the supplier countries (PM*) by a regression
relationship. The new equations for the United States and Canada are
shown in Appendix Table II.
Assumptions for Pressure of Demand Simulations
Alternative simulations were run using the period from mid-1964
to mid-1969 as a basis. It was assumed that outside the United States
and Canada economic activity and prices took their observed actual path.
For the United States and Canada it was assumed that the rate of expansion
of industrial activity corresponded to trend (4.6 per cent p.a. and
5.6 per cent p.a., respectively). The alternative runs assume that
growth can be maintained at a constant relative level above or below
the trend line; that is, with continuous more or less slack as measured
by the pressure of demand (PD) variable. Accordingly alternative PD's have
been assumed and, on the basis of available empirical evidance, corresponding
growth rates for the GNP deflator (PY) and export prices (PX) have been
introduced.
The alternatives considered were:
FORD is GERALD LIBRARY
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Per cent change annual rate
United States
Canada
PD
PY
PX
PY
PX
104
3.0
2.1
3.2
1.9
102
2.6
1.8
2.6
1.5
100
2.2
1.5
2.0
1.1
FORD
98
1.8
1.2
1.4
0.9
GERALD
96
1.4
1.0
0.8
0.4
LIBRARY
Results of Pressure of Demand Simulations
The results of these simulations for the United States are
summarized in Table 5. The second half year of 1964 is the base point,
but the first half of 1965 represents the first point to which the
simulation assumptions apply (exports and imports take a sharp shift from
second half 1964 to first half 1965 as a result). The time path of
exports and imports from the initial simulation point depends on the
underlying assumptions about industrial production, pressure of demand,
and prices. It is important to note that the rate of change in prices
has been adjusted corresponding to the level of PD assumption and that
the effect of alternative price and growth assumptions builds up over
time.
Table 5 shows that substantially different balance of trade
patterns result under different PD assumptions. The approximate impact
may be gauged by comparing deviations in the estimated trade balances
from the balance obtained by assuming PD = 100. In the first half of
1969, the U.S. trade balance under assumption of economic boom (PD = 104)
-24-
Table 5. Effect of varying levels of pressure of demand, at constant
growth rates, upon the U.S. trade balance expressed as
deviations from PD = 100
(billions of 1963 $, seasonally adjusted, annual rates)
PD = 104
PD = 102
PD = 100
PD = 98
PD = 96
1965 I
-.6 -
- .3
0
+.3
+.6
II
- .7
- .4
0
+.3
+.6
66 I
- .8
- .4
0
+.4
+.8
II
-1.0
- .5
0
+.5
+.9
67 I
-1.2
- .6
0
+.6
+1.1
II
-1.3
-.7
0
+.7
+1.3
68 I
-1.5
-.7
0
+.8
+1.5
II
-1.7
- .8 -
0
+.9
+1.7
69 I
-1.9
- .9
0
+1.0
+2.2
FORD is LIBRARY GERALD
BERALD FORD TBRART
-25-
is $4.1 billion (1963 dollars) less than under assumption of slack
(PD = 96). The time paths observed from the first simulation point
are also different: under the assumption of economic slack (PD = 96),
the trade balance shows a growing improvement over the moderate growth
assumption (PD = 100) from $.6 billion (1963 dollars) in the first half
of 1965 to $2.2 billion in the first half of 1969; the deterioration
of the trade balance in the comparison of boom (PD = 104) with moderate
growth, moves from $.6 billion to $1.9 billion over the same period.
It is important to note that the impact observed depends almost entirely
on the path of imports. The export results are obscured by the assumption
that changes in U.S. economic conditions are accompanied by similar changes
in Canadian economic activity. Since Canada is an important market
for U.S. exports, a lower PD for the United States, for example, will
result in lower U.S. exports, despite an export gain in other markets,
because Canadian expansion, PD and prices have been moderated at the
same time as the U.S. figures.
Of course, it is not realistic to assume growth paths which,
over a great length of time, deviate continuously and substantially from
reasonably high employment conditions. Furthermore, particularly under
the boom assumptions, price changes probably would accelerate -- and,
indeed, have accelerated -- a great deal more than has been built
into the model. Nevertheless, the present simulations were intended to
disentangle the possible effects of differential pressure of demand
conditions -- at constant rates of growth -- upon trade flows. And the
results demonstrate that these effects can be considerable.
8/ Similar runs making alternative assumptions about economic conditions
outside the United States may also be run.
-26-
Conclusion
The calculations made in this study present an approximate
measure of the impact of various types of alternative economic conditions
on trade. The study indicates that the past few years of inflationary
pressures in the United States have had substantial effects on the
trade balance. Quantification of these effects show that if demand
management policies had succeeded in achieving a steady non-inflationary
growth path for the United States economy from 1965 onward, the U.S.
trade balance would have been at least $3-1/2 billion higher in the
first half of 1969 than it actually was. If other industrial countries
at the same time had achieved continuous high employment of resources
throughout the period, the first half 1969 trade surplus might have
been $6 billion higher.
Furthermore, it can be shown that different rates of capacity
utilization, although combined with identical rates of growth, have
substantially different effects on the U.S. trade balance.
FORD is LIBRARY GERALD
APPENDIX
Table I
Import and Export Equations of Updated OECD Trade Model
Log - Log Formulations
IMPORTS
France
M = -.09 + 1.29 IP -1.49 PM + 1.19 PD+ + .02 LIB - .03 D
Germany
M = 1.23 + 1.69 IP - .27 PM - .35 PD - .33 PD.
Italy
M = .35 + 1.23 IP +1.14 APY + .71 PD -1.04 PM - .10D
U.K.
M = -1.54 + 1.62 IP - .29 PD + .004DSUR
U.S.
M = 4.37 + 1.48 GNP - .41 PM - .99 PDN
Canada
M = -.47 + 1.08 GNP -1.24 PM + 1.29 PD⁺
Japan
M = 1.46 + .82 IP - .77 PM + .62 PD⁺ + .54AIP
Other OECD M = -1.80 + 1.39 IP
Non OECD M = -.25 + .50 X-1 + .25 NCAP_1+ .32 RES1
EXPORTS
France
X = 3.28 + 1.02 S -1.41 PX + .69 PD. + .08 D
Germany
X = 3.84 + 1.24 S -1.18 PX + .04 PD. + .03 D1 - - .01D₂.
Italy
X = 3.83 + 1.62 S -1.50 PX - .06 D
U.K.
X = 1.53 + .56 S - .24 PX + .37 PD. + .19 D
U.S.
X = 2.28 + .80 S - .83 PX + .54 PD. + .01 D1 + .19 D₂
Canada
X = 4.62 + .90 S - .79 PX - .10 PD. - .08 D
Japan
X = -1.58 + 2.07 S -1.12 PX + .39 PD. + .22D1 + .13 D₂
Other OECD X = .11 + 1.09 S - .17 APX - .12 PD.
Non OECD X = 1.77 + .87 S - .26 PD.
FORD is LIBRARY GERALD
APPENDIX -2-
Table II
Import and Import Price Equations for the
United States and Canada for Pressure
of Demand Simulations
United States
M = 5.807 + .816IP + .333PD - 1.39PM/ + .096DST
PM = - ..478 + .764 PM* - .002TIM - .077PD + .428PDN
Canada
M = 4.022 + .840IP + .602PD - 1.303PM/
PM = 2.791 + .828PM* + .003TIM - - .448PD
FORD & LIBRARY 939470
APPENDIX -3-
Definition of Variables
All indexes are 1963 = 100
Price variables are in U.S. $ after allowing for parity changes
All weights are drawn from the 1963 trade matrix.
M Import volume index
IP Industrial Production index
PM Weighted average of export prices of supplier countries/ GNP deflator
of importing country
PM* Weighted average of export prices of supplier countries
PM Estimated import price
PM/ Estimated import price/GNP deflator of importing country
DST Steel strike dummy second half year 1959,
TIM Time trend
PD Ratio of industrial production over its semi-log trend level
PD⁺ Values of PD greater than 100, all other values are assumed to be 100
PD. Weighted average of PD in the market countries
PDN Weighted average of PD in countries supplying the U.S. market
LIB Trade liberalization variable
PY GNP deflator
X Exports volume index
NCAP Net capital flows
RES Foreign exchange reserves
S Market variable -- veighted average of estimated imports -- corresponds
to export estimates assuming constant market share in all markets
PX Export unit value index manufactured goods only
D various dummy variables
FORD & LIBRARY GERALD