Beggar-Thy-Neighbor Interest Rate Policies

Type:

SCID Working Paper 429

Author(s):

Published:

11/30/10

Abstract:

The United States is a sovereign country that has the right to follow its own monetary policy. By an accident of history, since 1945 it is also the center of the world dollar standard—which remains surprisingly robust to the present day. So the choice of monetary policy by the U.S. Federal Reserve can strongly affect its neighbors for better or for worse. Beginning with the Nixon shock in 1971, American policy makers have frequently ignored foreign complaints. But by ignoring feedback effects from the rest of the world, the Fed has made both the world and American economies less stable. The most recent example is the Fed’s policy of setting short-term interest rates close to zero since mid 2008, and then compounding this effect in late 2010 by “quantitative easing” designed to drive down long rates as well. At the November G-20 meeting in Seoul, foreign officials complained vociferously of hot money inflows from the United States creating inflationary pressure. Ironically, the Fed’s zero interest rate policy also impedes bank lending within the United States itself while seriously weakening other American financial institutions—such as insurance companies and pension funds.

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