The Great Dollar Shortage Debate: A Modern Perspective

Abstract: The dollar shortage debate -- Paul Samuelson called it “the big open question of our time” -- dominated international macroeconomics in the fifteen years following the end of World War II. We revisit it through the lenses of modern theory, namely, the intertemporal approach to the current account with financial frictions. We argue that its key elements, exemplified by the views of its main protagonist, Charles Kindleberger, have a remarkably modern flavor. Kindleberger identified the dollar shortage with the balance of payments deficit, a theoretically deficient but practically relevant and useful measure. He made early use of the permanent income/intertemporal approach to the current account and linked the persistence of trade imbalances to the income elasticities of savings and investment as well as to the persistence of U.S. technological superiority. The main shortcoming of the debate was the focus on the behavior of the current account rather than on the capital account as the chief reason of the dollar shortage. We also argue that currency shortages in general, whether past or present, arise from financial frictions and can occur under different international monetary systems and financial systems.

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