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The Fed reaches far

9th September 2019

The spectacle of US President Trump, attacking his own hand-picked Federal Reserve head Jerome Powell might seem to be just another sideshow. However, the President’s brazen attempts to influence Fed interest rate policy to save the US economy is more than alarming and far-reaching.

That’s because Fed policy has global impacts well beyond the chances of Trump being re-elected in 2020. At the annual meeting held in Jackson Hole last month, central bankers from around the world laid bets on how long it would take for President Trump to tweet after Powell’s opening remarks. It took 57 minutes for Powell to be labelled an “enemy” of the US.

The conference theme, “challenges for monetary policy” seemed unnervingly appropriate as central bankers grappled with trade policy impacts – including ongoing disputes initiated by Trump himself – on the global economy. Australia’s Reserve Bank governor Philip Lowe observed that business uncertainty was turning political shocks into economic ones. In defiance of the President views, the central bankers were largely unanimous in their scepticism that monetary policy would be able to offset negative trade war impacts.

For the Fed, Trump “policies” are complicating the already complicated task of keeping the US economy on track, which in turns is complicating monetary policy for the rest of the world. That’s because the US dollar has become even more influential since the global financial crisis. While the US accounts for just 15% of global GDP and 10% of world trade, it is used for half of the world’s trade invoicing and two-thirds of the emerging market external debt and two-thirds of foreign-exchange reserves.

IMF research discussed at the conference shows the greenback’s dominance in trade invoicing may prevent economies from adjusting to external shocks as effectively as traditional modelling would suggest. According to research from Stanford University, when the Fed raises interest rates, financial conditions tighten in the rest of the world. Emerging markets are particularly affected, as heightened perceptions of risk increase capital flight. Central banks are unable to shield their economies fully from this – raising interest rates sufficiently to retain capital would strangle the domestic economy – so exchange rates have to do the heavy lifting of adjustment.

The challenge facing the US Fed highlights the wider danger of the Trump Administration’s erratic and unpredictable “America First” approach when it comes to the global economy. Despite its determination to be a fortress, the US has an outsized influence on the global economy.