The Swinging Dollar: Is Europe Out of Step?

The large dollar fluctuations of the last decade are often viewed as a classic example of a lack of macroeconomic coordination. This paper examines these fluctuations from a European perspective and suggests five conclusions. First, interdependence between Europe and the US is quite limited as far as trade and income flows are concerned. Second, financial interdependence is intense. Third, and as a consequence of the nature of this interdependence, Europe has little incentive to stabilize its terms of trade vis-a-vis the US and would prefer instead to stabilize its real interest rate. Fourth, if the US takes the initiative and introduces a sharp change in its policy mix, it is by no means obvious that Europe's best course of action is to reciprocate, given that the US may react in turn. Fifth, as Europe is not a single country, the asymmetry between strong and weak European currencies allows the former to control their interest rates and leaves the latter in a more exposed situation. The analysis suggests that at present Europe is not likely to be willing to take much action to reduce global economic imbalances for the sake of assisting the United States. The irony, however, is that the domestic situation of most European countries does warrant the fiscal expansion which such a coordinated solution suggests.