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Published online by Cambridge University Press: 26 March 2020
To a large extent the seeds of the global stock market crash in October lie in the Louvre accord established at the beginning of this year. As we argue below, this agreement was fatally flawed in attempting to fix the dollar at too high a level. This error was initially both masked and aggravated by the extensive use of official intervention as the means of supporting the dollar. By the end of the summer it is estimated that up to two thirds of the US current account deficit was ‘covered’ by official intervention.
In preparing this forecast we had helpful discussions with various members of the Institute staff, and in particular Andrew Britton and George Ray.
The chapter contains detailed forecasts to the end of 1989 and medium-term projections to 1992. These are followed by two special sections. The first presents three forecast variants using simulations of our world model GEM. In variant A the G7 prevent the steady decline in the dollar assumed in our central forecast. Variant B examines the effects of a global rise in interest rates, while variant C looks at a sharp fall in the dollar precipitated by lower US interest rates. The second section focuses on the impact of international policy co-operation by describing some recent research using GEM. Although this highlights the potential benefits of co-operation, we also suggest that the recent Louvre accord was seriously flawed because it adopted exchange-rate targets that were incompatible with individual countries' own domestic demand objectives.
(1) ‘The time series consumption function revisited’, by A. Blinder and A. Deaton, Brookings Papers on Economic Activity, 2:1985.
(2) Data for the OECD countries are available in most cases only for the first half year. Data for the non-OECD sectors are sketchy even for 1986! There is also a large discrepancy in the available data for 1986 between a weighted average of import volumes, where growth exceeds 5½ per cent, and export volumes, where growth is below 4 per cent. Whereas in earlier Reviews world trade figures have been based on UN indices, the figures here reflect our own aggregation.
(3) Williamson, J. and Miller, M. (1987), ‘Targets and indicators: a blueprint for the international co-ordination of economic policy’, Institute of International Economics, Washington.
(4) However, capacity utilisation may be a useful intermediate target for inflation itself.
(5) Currie, D. and Wren-Lewis, S. (1987), ‘Evaluating the extended target zone proposal for the G3’, mimeo.