Fed faces new era of thinking global as Yellen nomination nears

Vice Chairman Janet Yellen is top candidate

China Growth

By 2027, China will have overtaken the U.S. as the largest economy in terms of market exchange rates and be more than 20 percent bigger by 2050, with India and Brazil also closing in, according to a January study by PriceWaterhouseCoopers LLP. The report estimated emerging markets will grow 4 percent a year from 2011 through the next four decades, almost double the U.S. pace.

“The biggest story in the global economy is the rise of Asia and other emerging markets,” said St. Louis Fed President James Bullard in a Sept. 20 interview. “So these are all factors that change the complexion of monetary-policy making in the U.S. over time.”

Paying attention overseas also is important because of the need to ensure financial stability when trouble in one country can be transmitted elsewhere through markets, according to Mark Gertler, who teaches economics at New York University. He sees central banks having to ensure common regulatory regimes or risk distorting capital.

“We live in a global world, and it’s important to account for that in policy,” said Gertler, who has written papers with Bernanke.

Too-Big-to-Fail Threat

The Financial Stability Board, the international banking regulator, currently is pushing nations to intensify efforts to end the so-called too-big-to-fail threat and share more information across borders so large banks can fold in a more orderly way than Lehman Brothers Holdings Inc. did in 2008. Policy makers also must complete talks on how banks manage risk and leverage.

Global forces have “repeatedly played a consequential role in the decision making” of the Fed, said Eichengreen, who wrote a paper entitled “Does the Fed Care About the Rest of the World?” for a July conference in Boston to mark the Fed’s centenary.

The central bank was founded partly because of the need to provide international markets with dollars to make it easier for U.S. exporters and financiers to win business abroad, said Eichengreen, a former IMF adviser.

Defend Gold

In the 1920s, the Fed sought to defend the gold standard and then responded to Britain’s 1931 exit by tightening monetary policy, putting exchange-rate stability over price and economic stability even amid the Great Depression, he said.

In the 1960s, the Fed paid attention to the U.S. balance of payments amid gold outflows -- sometimes leading policy to be tighter than inflation and the economy would suggest it should be, in Eichengreen’s calculations.

While he says international events have moved toward the edges of the Fed’s radar, other economists disagree.

The Fed loosened monetary policy in 1982 as Latin America’s debt crisis blew up and then again under Greenspan in 1998 as Asia and then Russia were roiled, even though the U.S. was midway through what would become a decade-long boom, according to Harvard University professor Jeffrey Frankel.

Policy Shift

“Even in recent years, the Fed has occasionally made a policy shift for international reasons,” said Frankel, a member of the Council of Economic Advisers under Yellen. “If there is a deep recession in Asia or elsewhere, it does affect us.”

Randall Kroszner, a Fed policy maker from 2006 to 2009 and now a professor at the University of Chicago, agrees the Fed has been forced to acknowledge and react to reverberations from abroad.

It united with fellow central banks in October 2008 to deliver a rare coordinated interest-rate cut and established and repeatedly augmented so-called currency swap lines with other monetary authorities to safeguard international access to dollars.

It assisted a 2011 intervention to restrain a surging yen and is involved in an international overhaul of banking regulation. The euro-area’s recent recession and the effects of Japan’s 2011 earthquake and tsunami also probably weighed on U.S. growth.

The Fed’s “been very engaged in international things,” Kroszner said. “The lesson of the crisis is it has to be. If a crisis starts, it has an enormous impact on the U.S.”

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