FRANKFURT (Reuters) – The US Federal Reserve’s historic shift to a more tolerant stance on inflation will burden the dollar for years and raise tough questions about the role of central banks, challenging policymakers from Frankfurt to Tokyo.
File photo: The Federal Reserve building faces a blue sky amid the Coronavirus Disease (COVID-19) outbreak, in Washington, USA, on May 1, 2020. REUTERS / Kevin Lamarck / File Photo
On the face of it, the Fed’s policy adjustment, unveiled on August 27, appears designed to give the US economy a chance in the arm. The shift to average inflation targeting allows the Fed to exceed its target after recessions, indicating that interest rate hikes will come later and allow the job market to run hotter, which is a boon for lower-income households.
But this causes two problems for global central banks.
The reinterpretation of the Fed’s mandate can be seen as an invasion of social policy, a vital precedent for others as they re-examine their roles after years of unconventional moves already affecting the distribution of wealth and income.
The second most pressing concern is the weak dollar, which is hurting exporters from Europe to Asia. This should feature prominently at the European Central Bank’s monetary policy meeting on Thursday, as the strength of the EUR = will make it difficult for eurozone exporting countries to emerge from the deepest recession in live memory.
Countries like Germany and France, or Japan, traditionally achieve growth from net exports, which is affected when their currencies become stable. This fixation exacerbates their problem as the trade wars between the United States and some of its major trading partners are already affecting exports.
Dollar. DXY = already weakened by more than 10% against a basket of currencies since mid-March to its lowest level in more than two years, prompting chief economist at the European Central Bank Philip Lane to warn last week that the exchange rate is important, even if the European Central Bank You did not target him.
Lin said, “If there are forces moving the EUR / USD rate, this feeds our global and European expectations and the preparation of our monetary policy.”
In fact, some economists say the current exchange rate may actually subtract 0.2% -0.4% of eurozone growth, and analysts polled by Reuters see further dollar weakness.
Usually it would not be very difficult to confront but the European Central Bank and the Bank of Japan are both close to very easy policy limits.
Both have cut interest rates into negative territory and returns are already negative on much of the curve. Both banks also face some domestic opposition to further easing, making the more moves politically complex.
“If the Fed delays in raising interest rates, it will increase pressure on the yen against the dollar,” said Hideo Komano, a former Bank of Japan official who is currently chief economist at the Dai Ichi Institute of Life Research.
“As long as the Fed’s policy makes it difficult for the dollar to rise, the Bank of Japan will have to worry about a possible rise in the yen that needs a policy response, including deepening negative interest rates,” he said.
Some economists argue that the European Central Bank should simply switch to a similar flexible target as part of its ongoing policy review. But market rates did not raise interest rates at all during Christine Lagarde’s eight-year tenure at the head of the bank, so the suggestion that policy tightening be pushed further raises issues of credibility.
“Emerging market economies, which are largely dollar-funded, will benefit, at least in the beginning,” said former ECB board member Benoit Coyeur. “Europe may need to find new ways to support its economy in the face of permanently low US interest rates.”
The Fed’s now clear goal of helping low-income families is another complication because it lifts the bank’s role in social policy and can be seen as a kind of reinterpretation of its mandate.
Bank of Japan Deputy Governor Masazumi Wakatap said, “Personally, I feel that there is room to look at the idea that some people have expressed, that monetary policy should focus more on working conditions and income.”
The European Central Bank also appears eager to reinterpret its mandate with Lagarde, arguing that the risks from climate change are so great that the bank cannot ignore them.
But central bank governors are unelected bureaucrats, and combating climate change or inequality is an intrusion into politics, threatening to open their banks to the kind of political attacks that could undermine independence.
The European Central Bank argues that its mandate does indeed require it to support the EU’s “general economic policies”, but such an explanation remains a shift given its current focus which is entirely on inflation.
However, some argue that the Fed’s shift will prove benign.
Lower dollar prices will reduce financing costs in emerging markets, accelerate growth and provide a larger market for exports. Allowing US inflation to rise now would raise both long-term rates and inflation expectations, facilitating policy normalization after years of extraordinary adjustment.
This may prove true, but that will not be apparent for years to come. Until then, central banks will have to deal with a weak dollar.
Co-reporting by Simon Johnson and Julie Gordon. Edited by Susan Fenton