Federal Reserve officials have been getting an earful about the economic threat that the US central bank’s rapid monetary tightening presents to the rest of the world — complaints that will no doubt be amplified at this week’s meetings of the International Monetary Fund and the World Bank.
The Fed must focus on what’s best for the US, so there’s little it can do to mitigate the global repercussions of its actions. That said, it should at least do a better job of explaining itself.
The complaints are amply founded: The Fed’s aggressive monetary tightening is undoubtedly imposing stress on the rest of the world, in large part by boosting the exchange rate of the dollar to other currencies. In developed countries, this drives up prices of imports such as crude oil, stoking inflation and forcing central banks to respond with matching rate hikes — even in economies where inflation pressures are relatively mild and growth is weaker. The effects are even harsher in developing countries. Aside from more expensive food and energy imports, they face reversals of foreign capital inflows (which makes financing imports harder) and increasing difficulty servicing their already burdensome dollar-denominated debts.
Yet the Fed will almost certainly stay the course, for two reasons. First, it’s the only way to get US inflation under control. Excessive fiscal and monetary stimulus stoked the demand for goods, services and labor, so the central bank must now tighten and push up unemployment enough to slow wage and price increases. If it fails to act aggressively enough, inflation will become more embedded, forcing the Fed to act even more forcefully later with even harsher consequences for the US and global economy.
Second, the Fed’s congressional mandate is to achieve maximum sustainable employment consistent with price stability for the US economy. Congress made no mention of what’s best for the rest of the world. Of course, the Fed pays attention to global developments such as the war in Ukraine, but only to the extent that they have implications for the US economic outlook. Fed officials explain their policies to their foreign counterparts, but no adjustments are made just because the latter are unhappy. This is standard operating procedure for central banks everywhere. What’s different is how much US monetary policy affects everyone else.
Still, the Fed could do more on the communication side. Specifically, officials would do well to be more forthcoming about what went wrong, and why they now must raise short-term rates by more than 400 basis points in just nine months. A couple talking points:
- The way the Fed implemented its new monetary policy framework, which from 2020 sought to target a longer-term average of 2% inflation, proved particularly ill-suited to the economic environment. The Fed’s self-imposed constraints were too extreme and inflexible: “Liftoff” from zero rates couldn’t happen until the economy had reached full employment and inflation had climbed above 2% and was expected to stay there for some time. Also, the Fed had to make “substantial” progress toward these goals before even beginning to taper the asset purchases known as quantitative easing, which had to be fully wound down before rate increases could begin. As a result, the federal funds rate was still at zero in early March, even though the economy had clearly overheated.
- The Fed made two important forecasting mistakes. Inflation pressures were much broader and more persistent than anticipated, and the labor market became much tighter much faster than expected.
Humility is always valuable when you have inadvertently made life more difficult for others. Also, by recognizing its mistakes, the Fed might provide some reassurance that it won’t repeat them. It’s not much to offer countries struggling to cope with the consequences, but it’s better than the alternative of saying nothing at all.
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
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