The Fed continues to focus on the U.S. economy as the world heads into a recession it could contribute to

The US Federal Reserve wields an outsized grip on global economies – yet it acts, in some ways, as if they don’t really matter.

Its power is mainly due to the US dollar dominancewhich has soared in recent months as the Fed aggressive interest rate hikes made the greenback more attractive to investors. But this has a downside for other countries because it fuels inflation, increases the cost of borrowing and increase the risk of a global recession.

If you only paid attention to the words of Fed Chairman Jerome Powell, however, you would probably have no idea what is going on. He hasn’t said a word in his public speeches about the significant risks to the global economy as the Fed and other central banks raise interest rates to keep inflation in check – including during their meetings at the end of September.

It might seem a little odd that the Fed seems so jaded about the global economy it arguably leads. Yet as finance researcherI think it makes perfect sense – although there are risks.

The Fed’s domestic stance

The Federal Reserve is responsible for focusing on the US economyand he takes this job very seriously.

While central banks are aware of all the global economic data, they are focusing on their own economies, helping them do what is best for their own nations. In the United States, this means that the Fed is focused on improving the American economy by
stable prices and full employment.

Therefore, when the U.S. economy slows down too quickly and people lose their jobs, like at the start of the pandemicthe fed lowers interest rates – regardless of the impact on other countries. Similarly, when the economy is growing but consumer prices are rising too fast, the central bank raises interest rates.

And its global impact

Yet it is inevitable that the policies of the Fed will influence the economies, businesses and citizens of virtually every country in the world.

While all central banks influence the rest of the world, the Fed has a much greater impact due to the size of the US economy – it remains by far the largest in absolute terms – and the importance of the US dollar in international markets and trade.

About half of the world’s international debt is denominated in dollar, which means that countries must pay interest and principle on what they borrow in dollars. The dollar soared almost 15% this year against a basket of foreign currencies, mainly due to the Fed’s interest rate hikes that began in March. This means that it is on average 15% more expensive to finance these dollar-denominated debts – and for some countries this could be much higher.

In addition, about 60% of all world foreign exchange reserves – this is the money that central banks hold to protect the value of their own currencies – are in dollars. And since most major commodities As oil and gold are denominated in dollars, a stronger dollar makes everything much more expensive for businesses and consumers in all countries.

Finally, when US interest rates are high relative to those in other countries, more foreign investment flows into the United States to get more bang for their buck. Since there is not much money to spend, it exhausts investment from other savings, especially emerging markets. And that means they have to raise interest rates to keep foreign direct investment flowing into their countries, which can hurt their local economies.

Risks in a globalized world

Unfortunately, focusing solely on the domestic economy carries its own risks.

It may sound cliché, but we live in a globalized and interconnected world – something powerfully demonstrated by the COVID-19 pandemic and time and time again supply chain issues. wavy across the world. American companies depend on other countries for their supplies, their workers and their consumers.
This means that even if the Fed achieves a proverbial soft landing and is able to reduce inflation without causing a recession, a global slowdown could still eventually reach US shores. This could threaten much of the Fed’s success if the global slowdown results in international instability or food insecurity.

So while I think the Fed is right to focus on the U.S. economy and raise rates at its September 21, 2022 meeting as much as it deems necessary, I will be looking closely at the economic projections for the central bank. If the data shows that the US economy’s inflation problems are easing, perhaps the Fed can start thinking a little less about what’s going on in its own backyard and more about the impact of its policies on the rest of the world.

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