The Federal Reserve is paying attention to the effects of its interest rate policies on other countries, despite President Donald Trump’s efforts to pit the Fed against the central banks of the world.
Deep in the Grand Teton mountains, central bankers from all over the world last week discussed the need for global thinking when setting domestic monetary policy. Bank of England Governor Mark Carney criticized the current international policy framework for prioritizing domestic economic growth and price stability in an increasingly global economy.
“The gains from policy coordination were thought to be modest at best, and the prescription was for countries to keep their houses in order,” Carney said at the Fed’s annual Jackson Hole conference in Wyoming. “This consensus is increasingly untenable.”
Trade and financial linkages have become more globally tied over the decades, and central bankers are now imploring the Federal Reserve — the steward of the largest economy in the world — to think about the effects of its policies on other countries.
Trump, meanwhile, wants the Fed to actually weaponize its monetary policy against other countries. Among his many criticisms of the Fed, Trump has called on the central bank to cut rates to match the low or negative interest rate policies in countries he considers competitors. Trump tweeted a day before the Jackson Hole conference began:
Germany sells 30 year bonds offering negative yields. Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home!— Donald J. Trump (@realDonaldTrump) August 22, 2019
In line with Trump’s rhetoric for “America First” policies, he recently endorsed Fox News contributor Mark Grant’s commentary that “The Fed is the Central Bank of the United States, not Central Bank of the World.”
But Fed officials are acknowledging the need for more globally minded policy, meaning the Fed is embracing monetary policy that more closely resembles the thinking of a central bank of the world.
“I think it's very important that we talk to one another,” Kansas City Fed President Esther George told Yahoo Finance on the sidelines of the Jackson Hole conference. “Because at some level, we all have the same challenges and the same objectives.”
The “global” interest rate
As Carney noted, most central banks have domestically focused mandates. In the U.S., Congress gave the Fed a dual mandate of price stability (inflation) and maximum employment (low unemployment).
The Fed steers its monetary policy, primarily through interest rates, based on its proximity to those goals. Policymakers like to point to estimates for a “neutral rate” as the appropriate level of interest rates where a central bank is closest to achieving its targets on price stability and maximum employment.
In many corners of the world, estimates of a country’s “neutral rate” have come down precipitously. The European Central Bank and the Bank of Japan have dipped into the unprecedented territory of negative interest rates. And here in the U.S., the economy is cruising at interest rates at levels half of where they were before the financial crisis.
At a glance, that makes the Fed’s nine rate hikes between 2015 and 2018 a curious policy move. While the world showed signs of slowing, the Fed tightened policy as domestic inflation stayed low and labor markets tightened to record levels of low unemployment.
The four rate hikes under Fed Chairman Jerome Powell have notably drawn the ire of Trump, who appointed Powell for the role in February 2018. In tweets, Trump bashed the central bank for tightening policy while the world was easing.
Because of the faulty thought process we have going for us at the Federal Reserve, we pay much higher interest rates than countries that are no match for us economically. In other words, our interest costs are much higher than other countries, when they should be lower. Correct!— Donald J. Trump (@realDonaldTrump) July 19, 2019
Trump has instead suggested that the Fed cut by as much as 100 basis points and resume asset purchases to help the U.S. call “game over” on his trade war with China.
In Jackson, Powell said trade has contributed to a “complex, turbulent” picture but made no promises on future moves. An hour later, Trump expressed frustration that the Fed did “nothing” (despite the fact that Powell’s speech was not a policy-setting announcement). That afternoon, Trump announced a new round of tariffs on China.
Politics aside, economists say that interest rate discrepancies are the result of local, short-run shocks. But in the long-run, local economies tend to have neutral interest rates that tend to closely track global interest rates.
“We stress that a direct comparison of interest rates across countries is too coarse a measure of monetary policy divergence or lack of monetary policy coordination,” said research from San Francisco Fed’s Òscar Jordà and University of California Davis’s Alan Taylor.
Turning to the world
Fed Chairman Jerome Powell described lower global interest rates as the most important question for the Fed in the current era of monetary policy.
“The key question raised by this era, then, is how we can best support maximum employment and price stability in a world with a low neutral interest rate,” Powell said August 23.
Answering that question may involve addressing the U.S. dollar, which has strengthened against most currencies over the last year and a half.
Carney warned that a stronger dollar threatens emerging markets, where central banks have had to shift their monetary policy resources away from their domestic mandates and toward defending their capital from fleeing to U.S. assets. Why should the U.S. care? Because volatility in emerging markets could “spill back on their economy,” Carney said.
In Jackson, the discussion swirled around longer-term structural changes to the global economy that would reduce volatility, such as a financial system where more than one currency dominates the world.
But President Trump, who is focused on the short-run implications of Fed policy, has blamed Powell’s interest rate hikes for driving U.S. dollar strength. Economists would argue that the demand for U.S. assets is also driven by investor expectations for brighter growth stateside compared to other corners of the world.
“It’s not a direct recipe, that if the Fed were to do more by cutting rates, that would necessarily weaken the dollar,” International Monetary Fund Chief Economic Gita Gopinath told Yahoo Finance.
As concerns built over trade and global growth, the Fed ended its hiking cycle and cut rates for the first time in over 10 years in July. Adam Posen, president of the Peterson Institute for International Economics, said Powell now a tough task: prioritizing domestic conditions but paying mind to impacts on the world, all while dodging criticism from the president.
“The president is so busy politicizing his talks about Chair Powell, about what the Fed is doing, casting it as though its an international race when its still mostly domestically driven, casting it as though its zero-sum when it’s actually a common problem facing the rich economies.”
The Fed’s next policy-setting announcement will take place September 18.
Brian Cheung is a reporter covering the banking industry and the intersection of finance and policy for Yahoo Finance. You can follow him on Twitter @bcheungz.