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FED’S TOLERANCE OF INFLATION TO BE A DRAG ON US DOLLAR

The US Federal Reserve’s landmark shift to a more tolerant stance on inflation will be a drag on the dollar for years and will raise hard questions about the role of central banking, challenging policymakers from Frankfurt to Tokyo.

On the face of it, the Fed’s policy tweak, unveiled on Aug. 27, appears tailored to giving the US economy a shot in the arm. A shift to average inflation targeting lets the Fed overshoot its target after downturns, indicating that rate hikes will come later and the jobs market will be allowed to run hotter, a boon to low-income families. But this creates two headaches for global central banks, Balazs Koranyi and Leika Kihara reported for Reuters on September 7, 2020.


Such a reinterpretation of the Fed’s mandate could be seen as a foray into social policy, a vital precedent for others as they reexamine their own roles after years of unconventional moves that already impact wealth and income distribution. The second, more immediate concern will be the dollar's weakness, which hurts exporters from Europe to Asia. This is bound to feature prominently at the European Central Bank's policy meeting on Thursday, as a strong euro will make it more difficult for exporting nations in the euro zone to climb out of their deepest recession in living memory.


Countries like Germany and France, or Japan, traditionally generate growth from net exports, which take a hit when their currencies firm. And this firming merely compounds their problem as trade wars between the United States and some of its key trade partners are already weighing on exports. The dollar has already weakened by over 10% against a basket of currencies since mid-March to a more than two-year low, prompting European Central Bank (ECB) chief economist Philip Lane to warn last week that the exchange rate mattered, even if the ECB didn’t target it. “If there are forces moving the euro/dollar rate around, that feeds into our global and European forecasts and our monetary policy setting,” Lane said. Indeed, some economists say that the current exchange rate could already deduct 0.2%-0.4% from euro zone growth and analysts polled by Reuters see more dollar weakness.


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