Monday, February 13, 2017

The Monetary Superpower: As Strong As Ever

In a forthcoming paper, Chris Crowe and I argue the Fed is a monetary superpower:
[A] defining feature of the US financial system is that its central bank, the Federal Reserve, has inordinate influence over global monetary conditions. Because of this influence, it shapes the growth path of global aggregate demand more than any other central bank does. This global reach of the Federal Reserve arises for three reasons. 
First, many emerging and some advanced economies either explicitly or implicitly peg their currency to the US dollar given its reserve currency status. Doing so, as first noted by Mundell (1963), implies these countries have delegated their monetary policy to the Federal Reserve as they have moved towards open capital markets over the past few decades. 
These “dollar bloc” countries, in other words, have effectively set their monetary policies on autopilot, exposed to the machinations of US monetary policy. Consequently, when the Federal Reserve adjusts its target interest rate or engages in quantitative easing, the periphery economies pegging to the dollar mostly follow suit with similar adjustments to their own monetary conditions.  
[...] 
The second reason for the global reach of US monetary policy is that a large and growing share of global credit is denominated in dollars. That means the Federal Reserve’s influence over the dollar’s value gives it influence over the external debt burdens of many countries.  
[...] 
The third reason for the extended reach of US monetary policy is that other  advanced- economy central banks are likely to be mindful of, and respond to, Federal Reserve policy given the large size of the dollar bloc...  These  findings imply that even  inflation- targeting central banks in advanced economies with developed financial markets are not immune from the influence of Federal Reserve policy. This has led Rey (2013, 2015) to argue that the standard macroeconomic trilemma view is incomplete. 
There is more in our article, but I wanted to share this excerpt because a new working paper from Ethan Ilzetzki, Carmen Reinhart, and Kenneth Rogoff sheds light on our claim that Fed is a monetary superpower. 

Specifically, this new paper shows that contrary to conventional wisdom exchange rate regimes across the world have not become significantly more flexible since the end of the Bretton Woods System. This surprising finding is backed up by a large cross-country data set that spans the period 1946-2015. Moreover, they show that the limited exchange rate flexibility has coincided with an expanding reach of the dollar. From their abstract:
Our central finding is that the US dollar scores (by a wide margin) as the world’s dominant anchor currency and, by some metrics, its use is far wider today than 70 years ago. 
Here is the key chart from their paper as it relates the monetary superpower argument. It shows the share of world GDP that has the dollar as its anchor currency:


What this graph implies is that about 70 percent of world GDP has its monetary policy effectively set by the FOMC! Given the size of the dollar bloc and its spillover effects, it is likely the Fed's total influence on global monetary conditions is even larger. 

This is staggering. It means that twelve Fed officials that meet in Washington D.C. largely determine global monetary conditions. The Fed is truly a monetary superpower. 

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4 comments:

  1. Egads, great post. 70% of global central banking keys on Fed.

    The Fed will suffocate global economy?

    Gary Cohn, Trump's top economic adviser, wants a softer dollar.

    I hope Trump listens!

    Vacancies galore on FOMC.

    ReplyDelete
  2. Egads, great post. 70% of global central banking keys on Fed.

    The Fed will suffocate global economy?

    Gary Cohn, Trump's top economic adviser, wants a softer dollar.

    I hope Trump listens!

    Vacancies galore on FOMC.

    ReplyDelete
  3. The other institution which needs exposure is the BIS (Bank for International Settlements.The Fed works directly with this corrupt institution. D

    ReplyDelete
  4. Nice monetary superpower hypothesis. But why is there a continued run up from 2005-2008 in foreign exchange reserves despite the taylor rule minus actual fed funds gap closing to zero?

    ReplyDelete