Stanley Fischer November 2015 Speech

The Transmission of Exchange Rate Changes to Output and Inflation

The exchange rate may mean as much for output as interest rates for a small economy

“When I was governor of the Bank of Israel prior to joining the Federal Reserve, my markets screen was continuously open at a chart of the exchange rate of the shekel against the dollar. For small open economies, the exchange rate may well matter as much for output and inflation as do interest rates.”

Two reasons for dollar strength: diverging monetary policy and lower risk tolerance

“Because foreign central banks responded appropriately by providing additional monetary accommodation, foreign interest rates have declined relative to U.S. interest rates, encouraging investors to shift into dollar-denominated assets and in turn boosting the dollar.”

“A second factor has been heightened concern about the global outlook and an associated decrease in investor risk tolerance–factors that tend to increase investment in dollar assets.”

Consumer price inflation has been held down by strong dollar

“consumer price inflation has been running well below the Federal Reserve’s 2 percent target, and the strong dollar has played an appreciable role in this shortfall.”

The stronger dollar has played on important role in policy path revisions

“The stronger dollar and some of the factors causing it, including weaker foreign demand, have played an important role in accounting for revisions to the expected path of U.S. policy rates compared with what was expected in the summer of last year.”

This degree of monetary accommodation seems appropriate…

“the federal funds rate below 1/2 percent at the end of 2015 before rising to only 1-1/2 percent at the end of 2016.10 This greater degree of monetary accommodation seems appropriate given the adverse effects on U.S. aggregate demand coming from the rise in the dollar, an associated weakening of foreign economic prospects, and other developments that have restrained spending and kept inflation undesirably low.”

The US economy is weathering the shock of the dollar’s appreciation relatively well. raising the fed funds rate in December will depend on committee’s assessment of progress towards goals of maximum employment and price stability

“To wrap up, while the dollar’s appreciation and foreign weakness have been a sizable shock, the U.S. economy appears to be weathering them reasonably well, notwithstanding their large effects on certain sectors of the economy heavily exposed to international trade. Monetary policy has played a key role in achieving these outcomes through deferring liftoff relative to what was expected a little over a year ago. The October 2015 FOMC statement indicated that it may be appropriate to raise the target range for the federal funds rate at the next meeting in December, though the outcome will depend on the Committee’s assessment of the progress–realized and expected–that has been made toward meeting our goals of maximum employment and price stability.11 Of course, as policymakers, we must always be vigilant to events unfolding differently than we expect, and we must be ready to react accordingly.”