The Monetary Superpower: As Strong As Ever

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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.  

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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.  

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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:

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. 

• The International Impact of the Fed When the United States is a Banker to the World (Working paper version of my forthcoming article with Chris Crowe)
• Exchange Arrangements Entering the 21st Century: Which Anchor Will Hold?–Ethan Ilzetzki, Carmen Reinhart, and Kenneth Rogoff
• The Great Liquidity Boom and the Monetary Superpower Hypothesis (My first article with Chris Crowe were we originally lay out the monetary superpower idea.)
• Responding to a Monetary Superpower: Investigating the Behavioral Spillovers of U.S. Monetary Policy–Colin Gray