Fed vs. ECB

An Unintended War

Mario Draghi ECB Janet Yellen Fed chair DISTORTED Source Reuters 38803762
Calm before the storm? ECB boss Mario Draghi and Fed chief Janet Yellen.
  • Why it matters

    Why it matters

    Uncoordinated monetary policy actions in Europe can hurt economic development in the United States.

  • Facts


    • The Federal Reserve chairwoman, Janet Yellen, is worried about the strong dollar.
    • The dollar has appreciated by 11 percent against the euro in the past three months.
    • The European Central Bank’s €1.1 trillion bond-buying program has caused a depreciation of the euro.
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Not every war that breaks out is really intended. Sometimes both sides simply stumble into each other.

That is also the case in currency wars. In the politics of money, central banks can compete over currency values solely because they look at economic data and react.

This is the danger now facing Europe and the United States.

Last week, Federal Reserve chairwoman Janet Yellen made no secret of the fact that the strong dollar worries her.

Monetary policy makers don’t normally like to argue with the exchange rate, because it’s not one of their official target figures.

The strengthening dollar lowers the cost of imports and, along with weak oil prices, means U.S. inflation will likely remain below the 2 percent annual target. In addition, Ms. Yellen mentioned the strong dollar in relation to weak U.S. exports.

She also said: “The dollar rate is also an expression of the economic strength of America.” But that was, so to speak, only an added remark.

Until recently, a strong dollar didn’t seem to be a problem for the United States. U.S. economists mostly believed the domestic economy could tolerate a strong currency, because the dependence on exports was kept within limits.

Many thought the euro, as measured by the economic problems of its member states, was valued too highly. They were waiting only for Mario Draghi, head of the European Central Bank, to finally go full swing with bond buying and devalue the euro to better fit economic reality. Some even thought he took too long to do it.

So it could be predicted that it would eventually come down to tension over monetary policies: The Fed pulls in the reins, and the ECB lets them loose.

But since Mr. Draghi started his multi-billion euro bond-buying (quantitive-easing) program, the euro fell much more than expected, and the dollar rose much more. Suddenly economists were concerned that the dollar was too strong for the slowly growing U.S. economy. And Ms. Yellen picked up that concern with surprising speed.

Monetary policy makers don’t normally like to argue with the exchange rate, because it’s not one of their official target figures. But when they do take it up, it is much more noticeable.

To understand the danger, one must understand that Mr. Draghi has, to an extent, already reacted to a previous Fed policy.

Just a few months ago, there was still speculation about why the euro remained so strong compared to the dollar despite economic weakness in Europe. The puzzle was easy to solve by looking at balance sheets of the two central banks. The ECB had let its money supply shrink after a momentary growth spurt during its aid program to banks in 2012 and 2013.

In contrast, the Fed pumped up its balance through bond buying until last fall. Now it is not buying additional bonds, but continues to renew maturing bonds.

Ms. Yellen and Mr. Draghi must talk to one another.

Before the beginning of his bond program, Mr. Draghi said his goal was to pump up the balance of the ECB. At the same time, he said the euro was too strong. What he did then is clear: He basically responded to the previous Fed policy and brought his balance to a comparable level.

Regardless of the strong dollar, the Fed will almost certainly raise interest rates for the first time since the financial crisis. But when will it act and how far will it go?

The next questions are: How long will it take to gradually decrease the U.S. central bank’s enormous balance sheet? And won’t that make the dollar even stronger?

If the Fed allows itself to be too influenced by the strong dollar, which indirectly spills over into relevant economic data, then central banks are in danger of falling into a trap. Because then no one can get out of its crisis mode of monetary policy – for fear of again falling into crisis.

At the same time, monetary policies can neutralize one another. Americans might prefer to let the dollar be somewhat weaker, thereby partially off-setting Mr. Draghi’s program.

All in all, it means one thing: Ms. Yellen and Mr. Draghi must talk to one another and coordinate. It is not enough anymore to create monetary policies only according to one’s own domestic data.


To contact the author: wiebe@handelsblatt.com

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