Change in Fed strategy to link big central banks from Frankfurt to Tokyo


FRANKFURT (Reuters) – The US Federal Reserve’s historic shift to a more tolerant stance on inflation will dampen the dollar for years and raise tough questions about the role of the central bank, challenging policymakers from Frankfurt to Tokyo.

FILE PHOTO: The Federal Reserve building sits against a blue sky, amid the coronavirus (COVID-19) outbreak, in Washington, United States, May 1, 2020. REUTERS / Kevin Lamarque / File Photo

At first glance, the Fed’s policy adjustment, unveiled on August 27, appears designed to give the US economy a boost. A shift to an average inflation target allows the Fed to exceed its target after a recession, indicating that rate hikes will come later and the job market will be allowed to warm up, a boon for families in need. low income.

But this creates two headaches for the world’s central banks.

Such a reinterpretation of the Fed’s mandate could be seen as a foray into social policy, a vital precedent for others as they re-examine their own roles after years of unconventional moves that are already impacting the distribution of labor. wealth and income.

The second and more immediate concern will be the weakness of the dollar, which is hurting European exporters to Asia. This should feature prominently at the European Central Bank policy meeting on Thursday, as a strong EUR = euro will make it harder for eurozone exporting countries to emerge from their deepest recession in living memory.

Countries like Germany and France, or Japan, traditionally generate growth through net exports, which suffer when their currencies strengthen. And this strengthening only makes their problem worse, as trade wars between the United States and some of its major trading partners are already weighing on exports.

The dollar .DXY = has already weakened more than 10% against a basket of currencies since mid-March to a more than two-year low, prompting ECB chief economist Philip Lane to warn last week that the exchange rate mattered, even though the ECB did not target it.

“If there are forces that move the euro / dollar rate, that feeds our global and European forecasts and our monetary policy,” Lane said.

Indeed, some economists argue that the current exchange rate could already deduct 0.2% -0.4% from euro area growth and analysts polled by Reuters see more dollar weakness.

Normally, that wouldn’t be too hard to counter, but the ECB and the Bank of Japan are both close to the limits of super easy politics.

Both have lowered rates into negative territory and yields are already negative across much of the curve. Both banks also face some domestic opposition to further easing, which politically complicates other measures.

“If the Fed were to lag behind in raising interest rates, it would put upward pressure on the yen against the dollar,” said Hideo Kumano, a former BOJ official who is currently chief economist. at the Dai-ichi Life Research Institute.

“As long as the Fed’s policy makes it harder for the dollar to rise, the BOJ will have to worry about the potential rise of the yen which requires a policy response, including worsening negative interest rates,” he said. he declares.

Some economists argue that the ECB should simply switch to an equally flexible target as part of its own ongoing policy review. But markets aren’t forecasting any rate hikes during Christine Lagarde’s eight-year tenure as the bank’s head, so a suggestion that the policy tightening would be even deeper raises credibility issues.

“Emerging market economies, which are largely funded in dollars, will benefit, at least initially,” said former ECB board member Benoit Coeure. “Europe may have to find new ways to support its economy in the face of ever lower US rates.”


Another complication is the Fed’s now explicit goal of helping low-income families as it elevates the bank’s role in social policy and could be seen as a sort of reinterpretation of its mandate.

“Personally, I believe that it is possible to consider the idea, expressed by some people, that monetary policy should focus more on employment and income conditions,” said the deputy governor of the BOJ, Masazumi Wakatabe.

The ECB also appears keen to reinterpret its mandate with Lagarde arguing that the risks created by climate change are so great the bank could not ignore them.

But central bankers are unelected bureaucrats, and tackling climate change or inequality is a foray into politics, which risks opening up their banks to the kind of political attacks that could undermine independence.

The ECB argues that its mandate already requires it to support the “general economic policies” of the European Union, but such an interpretation would still represent a change given its current orientation which is entirely focused on inflation.

Still, some argue that the Fed’s change will prove to be benign.

Lower dollar rates will lower financing costs in emerging markets, accelerate growth and provide a larger market for exports. And letting inflation in the United States rise now will raise both long-term rates and inflation expectations, making it easier to normalize policies after years of extraordinary accommodations.

These may turn out to be true, but it will not be evident in the years to come. And by then, central banks have to deal with a weaker dollar.

Additional reporting by Simon Johnson and Julie Gordon; Edited by Susan Fenton

Our standards:Thomson Reuters Trust Principles.


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