Does Raising U.S. Interest Rates Make Sense in an Era of a Strong Dollar?

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By Jacob Maslow

Federal Reserve Building
Close-up of Federal Reserve Building in Washington DC

If a central bank raises interest rates, the currency being overseen and supervised by that central bank tends to appreciate in value. Global investors would snap up that currency because they would be getting a higher return by buying that currency. This increases the value of the currency even more. In many cases, increasing interest rates can lead to an upward spiral as far as currency valuation is concerned.

This is a major headache for the United States. It seems that the U.S. Federal Reserve is caught between a rock and a hard place. On the one hand, it says that there are some inflationary pressures being put on the United States and it has to put on the brakes. Otherwise, inflation might blow up and this might jeopardize the U.S. economic recovery. This is pretty straightforward; this is very easy to understand. Usually, inflation does destroy economic growth. That is an established fact.

However, the rate of inflation in the United States seems so tame that this level of alarm at the Fed seems rather unwarranted. The downside to being overly eager to increase interest rates is that this will make the dollar even stronger. As it stands, the U.S. is the only bright spot on the globe as far as economic growth is concerned. Even the U.S. GDP growth is showing signs of a slowdown. But the U.S. economy still smells like roses compared to Europe, Japan, and pretty much elsewhere.

Keep in mind that even China’s amazing growth rates have slowed down quite a bit. Indeed, it just registered its slowest GDP growth rate in over two decades. The global economy is slowing down, and it doesn’t look like it would help the United States if it increases interest rates. The strong dollar will put a lot of pressure on its exporters and this can lead to job losses. Moreover, the U.S. has to give up some of its export gains because of the strong dollar. Unless this is compensated for by stronger growth through domestic consumption and internal trade, this might be a bad move.

Moreover, if you factor in the deflationary effect of 50% reduction in global oil prices, it is really hard to understand where the Fed gets its inflation numbers from. Sure, there may be inflationary blips here and there. But the real problem facing the world as far as developed economies are concernedis deflation, not inflation.

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