Friday, October 23, 2009

More Evidence the Fed is a Monetary Superpower

I have the made the case many times that the Fed is a monetary superpower. Recent developments seem to confirm this view: the Fed's low interest rate policy is making it difficult for other countries to raise their interest rates lest their currencies strengthen and they lose external competitiveness to the United States. Here is Vincent Fernando:

There's a huge problem with the entire world trying to have weaker currencies relative to the dollar right now.

It's that they've all become slaves to U.S. interest rate policy, even more so than they already may have been.

Right now, raising interest rates in any country before the U.S. does so is likely to strengthen that country's currency against the dollar, all else being equal.


For countries with a strong desire to keep exports competitive, that's a big problem.

Thus the Eurozone, the U.K., and most international countries have to decide whether their own fear of currency strength is worth the collateral damage it causes at home.

And you thought the ECB was a truly independent central bank? The Economist also has an article that touches on this issue:

The ECB will eventually face a problem that some central banks are already encountering. As long as America keeps its interest rates low, attempts by others to tighten policy (even stealthy ones that leave benchmark rates unchanged) are likely to mean a stronger currency. That is a price that Australia’s central bank seems prepared to pay. The minutes of its policy meeting on October 6th, at which it raised its main interest rate, revealed the exchange rate was not a consideration. The bank’s rate-setters ascribed the Australian dollar’s rise to the economy’s resilience and strong commodity prices. In New Zealand, similarly, the central-bank governor, Alan Bollard, told politicians that the kiwi dollar’s strength would not stand in the way of higher rates.

Note that this means the Fed is setting global liquidity conditions, just as it did during the early-to-mid 2000s. The Fed's official mandate is the U.S. economy, but its reach is global.


  1. Actually, I do not believe that the Fed necessarily is a monetary superpower. It is just that, when the Fed eases, the response in the dollar tends to lead the response in US domestic prices, so there is a period when the other countries lose competitiveness against the US, and in practice, it is politically difficult for the other central banks to bear the short term cost of holding their independent line. The process can be observed at work in the eurozone. What is needed is central bankers around the world with more guts.

  2. RebelEconomist:

    I agree it is not a given the Fed will be a monetary superpower. But as long as all the emerging countries that either implicitly or explicitly peg to dollar continue to do so and to the extent this "dollar block" is large enough to put pressure on the ECB and BoJ to keep their currencies competitively valued the Fed will continue to have the role by default.

    Or, as you note, if the ECB or BoE decide to hold the line this could put the end to Fed's hegemony.

  3. I suspect that, if the eurozone wants a larger reserve role for the euro, asserting an independent line from the Fed would be a big step forward (ie demonstrating the hard nature of the euro). There are advantages to reserve status providing the currency issuer handles it wisely (unlike the US), but there may be a pain barrier to go through on the way.