Friday, February 6, 2015

One of the greatest exports of the US - monetary policy

Countries often think about export policy and the overall balance of payments in the context of economic growth. The US, however, has to realize that its greatest export may be monetary policy. As a reserve currency the actions of the Fed will spill over to other countries. When policies are loose, we export growth and potential inflation. When policies are tight, there is the potential for a growth slowdown. The reason is simple. Even in a flexible exchange rate system, the action of the reserve currency will have spill-over to other countries. This is especially the case when the "importers" are small relative to the US. If nothing is done, market forces will cause dollar behavior to impact other countries. Countries have to offset or mitigate the impact of dollar moves.

A new paper by Sebastian Edwards on the independence of monetary policy for those countries that have flexible exchange rates focuses on this issue. He focuses on examples in Latin America. Countries with flexible exchange rates should be able to pursue independent monetary policy, but many are not as independent as theory would suggest when there is a large size differential. Monetary independence may be an illusion for emerging market countries.


No comments: