The Fed's Disturbing Monetary Policy Options
All eyes were on a September rate hike (and some still are). But the minutes from their latest meeting suggest that the Federal Open Market Committee has not made up its mind. The Fed’s ambivalence was not surprising, but some of the nondomestic reasons for it—China, oil and the strong dollar—were.
Of course, the minutes also cited stubbornly low domestic inflation and a general lack of wage pressures as concerns for raising rates too early. The Fed is tasked only with achieving targets in the United States. Not globally.
When topics concerning the global economy are raised, they are carefully grounded in their particular interaction with the U.S. economy. Take one comment on how participants are thinking about the evolution of the dollar as they begin to hike rates:
“Some participants also discussed the risk that a possible divergence in interest rates in the United States and abroad might lead to further appreciation of the dollar, extending the downward pressure on commodity prices and the weakness in net exports.”
No mention is made of the capital flight from the emerging world in the face of a rising dollar, or the slowdown in commodity producing countries due to lower prices for their exports.
This begs the question: Was the Fed simply making an attempt to placate other central banks that fear Fed actions could destroy their domestic economies? Or was it trying to become independent of its previous targets?
The answer is probably a bit of both. Given its dual mandate targets, the Fed could and still may take action in September. But, for a variety of reasons, the Fed may want to wait, and global macro concerns give it a viable, nebulous reason to do so. It may also allow the Fed to pursue easing until wage pressures and inflation reemerge. But there is also a bit of a friendly warning embedded in there. In diverging from the global easing policies of other central banks, the Fed is aware of what damage it will cause to the emerging world. Eventually, the Fed will act anyway.
In choosing to debate the effects of Fed policy on the global economy, however, the Fed has invited speculation into whether its guideposts for policy tightening have moved, and put itself into an impossible spot. If the Fed does begin to use more of a “global macro prudential” policy to guide markets, it will become increasingly difficult to maintain credibility in policy decisions. (There is usually a reason to ease—risks are abundant, and there are frequently reasons to tighten policy—there is a bubble everywhere.) It would also raise the question of whether the Fed should be concerned about anything outside of its dual mandate (oil prices and net exports have a direct effect on their dual mandate through inflation and employment).
If all the guideposts are the same and the Fed does not raise interest rates, it risks signaling a weak domestic economic background—something of a self-fulfilling prophecy.
Not raising rates would place downward pressure on the dollar and upward pressure on commodity prices. This would be ideal for the United States—the U.S. dollar has strengthened drastically over the past year, and declines in oil capital expenditures and employment have been holding back U.S. growth.
But this scenario would not be ideal for much of the world. Central banks in Japan and Europe have been easing policy significantly, and a shift away from tightening in the United States would lower the efficacy of their policies. Even China’s central bank has liberalized its currency regime, presumably in part to avoid getting caught in a Fed tightening cycle and give itself the ability to devalue against the dollar. By paying attention to global stability and the effects of a stronger dollar, the Fed may cause other central banks to increase their stimulus policies, thereby making it even more difficult for the Fed to move. If the Fed were to simply increase rates, those banks’ policies would require less ammunition in the form of easing. Conversely, a continued easing by other countries would strengthen the dollar, damaging the U.S. economy.
The Fed wants to appear prudent in its monetary policies—and avoid blame for another bubble. So much so, that its guideposts for an initial rate hike—previously a mixture of employment and inflation indicators—now seem to include global macro variables that are outside the direct purview of monetary policy. Being concerned with the global economy makes the Fed’s task, which is already difficult, impossible. And, in the case of lifting off its zero interest rate policy, there do not appear to be any good choices.