By Peter Morici
Federal Reserve policymakers meet Tuesday to consider when to raise interest rates, but the strong dollar and inflation risks put them between a rock and a hard place.
Facing tough structural problems and disappointing growth, monetary authorities in Europe, China and Japan have cut interest rates and taken extraordinary measures to push liquidity through banks and boost private spending.
Low rates and more liquidity abroad have attracted more investment to U.S. alternatives, boosting the dollar against the currencies of major trading partners by about 15 percent since last summer. This makes foreign goods and services less expensive in U.S. markets and American exports more expensive and harder to sell abroad.
Both slow U.S. industrial activity, and the New York Federal Reserve Bank estimates a stronger dollar is slicing about 0.6 percent, or $100 billion, off GDP. That should translate into about 850,000 fewer Americans employed.
A stronger greenback also drags on the profitability of U.S. firms that both produce and sell abroad. By raising interest rates this summer, the Fed would make U.S. investments even more attractive to foreigners, further strengthen the dollar and exacerbate all those adverse consequences.
Still, the Fed has good reasons to want higher U.S. interest rates.
Prolonged periods of low rates distort the allocation of capital among competing uses across the economy, discouraging lending to small and medium-sized businesses.
The recent prolonged period of low rates and narrow spreads adds to pressures on smaller banks to seek mergers with larger banks.
Easy money policies in the United States and around the globe have not pushed up prices. Excess capacity abounds for the production of many basic commodities and among Asian manufacturers that supply stores around the globe.
Unprofitable capacity will eventually shut down, and once inflation gets going it can become difficult to contain.
Fed Chairwoman Janet Yellen has expressed confidence that inflation will pick up as we move through 2015 and has been steadily been preparing markets for the Fed to begin raising interest rates sometime this summer or fall.
However, higher U.S. interest rates would attract more foreign investment, further bid up the dollar against foreign currencies and increase pressures on U.S. firms competing in international markets. All would discourage a quicker pace of wage increases and hiring, and generally keep the recovery in low gear.
For the Fed, it’s a Hobson’s choice – either sentence the U.S. economy to continued slow growth or risk letting the inflation genie out of the bottle.
Peter Morici is an economist and professor at the University of Maryland and a national columnist.