JACKSON HOLE, Wyo. (Reuters) – Over the decades since World War Two the growth rates, inflation rates, interest rates and business cycles of the world’s major economies grew closer together.
In hindsight and in that context, the U.S. Federal Reserve’s efforts to raise interest rates may have been doomed from the start, undone by global trends that now limit any given central bank’s ability to move too far on its own.
That is the conclusion of research presented on Friday at the U.S. central bank’s annual conference in Jackson Hole, Wyoming. This year’s gathering is focused on the challenges to monetary policy a decade after a deep global and U.S. recession.
The premise is not a new one – that financial integration and the global flow of capital have tethered the world’s economies together. But the details suggest the level of dependence among countries, and the constraints that poses for central banks, now exists “to a degree perhaps insufficiently appreciated,” wrote authors Oscar Jorda of the San Francisco Fed and Alan Taylor of the University of California, Davis.
“Ignoring such trends risks provoking internal and external imbalances, as well as unwanted dislocation,” they concluded in research that looked at how the underlying equilibrium rates of interest relevant to each country’s monetary policy have become more globally determined.
Notably, when one central bank such as the Fed moves on its own, “in a world of capital mobility this must inevitably perturb exchange rate equilibrium … Now, talk of currency wars and exchange rate manipulation has once more started to make headlines.”
The strength of the U.S. dollar, and its potential to make U.S. exports more expensive, and thus less competitive around the world, is one of the chief grievances President Donald Trump has lodged against the Fed, while also accusing central bankers in other parts of the world, including Europe, of acting deliberately on that front to gain an advantage.
The paper provided a less polemical grounding for what the Fed might have gotten wrong last year as it continued raising interest rates even as financial markets showed some signs that financial conditions were tightening too much.
As they acted last year, Fed policymakers used as a reference their estimates of the “neutral” rate of interest for the U.S. economy, a rough target for where they thought the central bank’s policy interest rate should be set.
Those estimates have been dropping, but the research suggested global factors may have pulled the neutral rate even lower still.
That could have caused the Fed to overstep in its final rate hikes in 2018, a possibility U.S. central bank officials have acknowledged.
The Fed cut its key overnight lending rate at its last policy meeting in July, and officials have cited global factors as weighing on that decision.
It may not be the last time.
“A central bank has a duty to protect the economic and financial welfare of its citizens,” the authors concluded. “In a globalized economy with low rates of growth, low neutral real rates of interest, and tight financial integration, carrying out that duty will inevitably require central banks to adopt a global perspective.”
Reporting by Howard Schneider; Editing by Paul Simao