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The Fed’s Latest Policy Threatens Other Central Banks

 

The Fed’s policy changes, which were launched on August 27, are called to adjust to the US economy. A shift in the average inflation target allows the Fed to exceed its economic target after a downturn.

This indicates that the interest rate hike will come later and employment will increase. This is an advantage for low-income families.

But this move poses problems for other central banks globally. Such reinterpretation of the Fed’s mandate can be seen as a downturn in social policy, the Fed’s previous actions already impacting wealth and income distribution.

The second, more pressing concern is a weaker US dollar, which hurts exporters from Europe to Asia. This will definitely be discussed at the European Central Bank’s policy meeting on Thursday.

The strengthening of the euro currency will make it difficult for exporting countries in the eurozone to escape recession. Countries like Germany and France, or Japan, traditionally generate growth from net exports, which will take a hit when their currencies strengthen.

And this strengthening has only compounded their problems because the trade war between the United States and some of its major trading partners has weighed on exports.

The US dollar has weakened more than 10 percent against a number of currencies since mid-March to its lowest level in more than two years. ECB chief economist Philip Lane warned that exchange rates matter, even if the ECB doesn’t target them.

“If there is any force driving the euro exchange rate against the dollar, it will fit into our global and European forecasts and our monetary policy settings,” Lane said.

Some economists say that the current exchange rate can reduce 0.2 percent to 0.4 percent of eurozone growth. Analysts surveyed by Reuters saw more weakness in the US dollar. Usually this wouldn’t be too difficult to counter, but the ECB and the Bank of Japan are both close to policy limits.

Both have cut rates into negative territory and the yield is already negative for most of the curve. The two banks also face some domestic opposition to further easing, making political steps more complicated.

“If the Fed is going to be late in raising interest rates, it will put pressure on the yen against the dollar,” said Hideo Kumano, a former BOJ official who currently serves as chief economist at the Dai-ichi Life Research Institute.

As long as Fed policy complicates the dollar’s rise, the BOJ should worry about a potential yen hike requiring a policy response including a deepening of negative interest rates. Some economists argue that the ECB should shift to equally flexible targets as part of its own ongoing policy review.

But at market prices there was no increase in interest rates at all during the eight year period. So the suggestion that policy tightening would be further pushed raises credibility issues.

“Emerging market economies, which are largely dollar-funded, will benefit, at least initially,” said former ECB board member Benoit Coeure. He said Europe may need to find new ways to support its economy in the face of permanently lower US tariffs.

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