Our Currency, Everyone’s Problem
Is the Federal Reserve’s decision to hold interest rates at zero more about the U.S. or the global economy?
A move on the part of the U.S. Federal Reserve to increase interest rates from their present level of zero has been “forthcoming” for almost two years now. Fed Chair Janet Yellen hinted just a few months ago that the central bank was ready to this fall. And yet when the Open Market Committee met last week, they decided, once again, to put the pending rate increase on hold.
On previous occasions, this kind of restraint, following what had appeared to be clear warnings that a rate increase was coming, might have sparked concern and confused markets. This time, however, investors were prepared to wait — but not because of stumbles within the U.S. economy. Instead, recent market volatility in China — the result of a badly timed exchange rate adjustment in August and subsequent sharp currency depreciation — and concerns about the resilience of other BRICS countries had shifted investors’ expectations; as a result, when rates stayed the same the markets hardly batted an eye — even if some traders felt irked.
As the collective memory of what it looks like to have interest rates above zero begins to fade — the last time there was a rate increase was 2006 — the Fed seems to be growing both more in tune with the global economic outlook and more willing to take into account the impact of its monetary policy on the rest of the world. Is this a result of Yellen’s generally dovish and cautious approach to policymaking? Or has the Fed learned its lesson from 2013, when the previous Fed chairman, Ben Bernanke, announced in advance his intention to phase out the bank’s quantitative easing program, sparking a “taper tantrum” across emerging markets from Brazil to Indonesia?
Whatever the Fed’s reasoning, it is good news for the rest of the world. The global financial crisis of 2008 has shown that countries are much more financially integrated than was the case just 30 years ago, and that financial contagion spreads much more quickly. Consider, for example, the expansion, since 1990, in total cross-border capital flows (the money that moves between countries in order to be invested in factories, plants, infrastructure, or in bonds and stocks). Today, this flow of money totals approximately $26 trillion worldwide, 38 percent of which comes from emerging economies, up from 14 percent in 1990.
Within the world economy, the United States remains the main systemically important country. It issues the key international reserve currency. Dollars are used to invoice and settle approximately 80 percent of the world’s trade, and dollar-denominated assets represent about two-thirds of central banks’ known reserves. U.S. monetary policy still matters to the rest of the world at a level that China’s simply does not.
The Fed’s decision has thus helped out all the various emerging market economies that have recently faced capital outflows and the collapse of their currencies. China is not unique in struggling to cope with money leaving the country and with a faltering renminbi. Brazil’s real collapsed after the country’s credit rating was downgraded to junk status. Russia has been struggling for months to prop up the value of the ruble. Foreign exchange reserves, accumulated during years of strong export demand and high oil and commodities prices, are now being used to try to keep a floor under these exchange rates: Russia’s reserves are now at 76 percent of what they were just a year ago, while China’s foreign exchange holdings have fallen to approximately $3.5 trillion from a peak of $4 trillion in July 2014.
Of course, the Fed’s policy mandate is not to support the world economy. Rather, it is to pursue its statutory objectives of “maximum employment, stable prices and moderate long-term interest rates” in the United States. But this mandate can be interpreted narrowly or broadly. And as stewards of the world’s largest foreign direct investor — with approximately $340 billion invested around the world — a prosperous and balanced world economy should be a concern for U.S. policymakers, and is very much tied to ensuring that the domestic economy remains strong.
Assessing the spillover impact of economic policies should be a no-brainer for systemically important countries like the United States, especially when the objective of preserving international financial stability does not conflict with domestic policy goals. With no inflationary pressures — the consumer prices index in August was down 0.1 percent — and GDP now on track to grow at around 3 percent after slowing down earlier this year, the Fed can afford to go beyond domestic considerations. Being the world’s leading financial and monetary power comes with responsibilities: in the post-global financial crisis world “our currency, but your problem” is no longer acceptable.
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