The U.S. would reduce its imports as a result of monetary policy

The United States would reduce its imports as a result of the Federal Reserve’s tightening of monetary policy, noted Catherine L. Mann, a member of the Bank of England’s Monetary Policy Committee.

While the domestic effects of monetary tightening are (relatively) well established, the net effect on economies abroad is a priori ambiguous, she said.

On the one hand, through slowing US domestic demand, US monetary tightening will reduce demand for goods and services produced abroad.

The global demand channel causes a slowdown in activity and disinflation.

On the other hand, other things being equal, a tightening of monetary policy in the United States should appreciate the dollar against foreign currencies, as compensation for holding dollar-denominated assets increases and capital flows to the United States increase.

Mann argues that it is well documented that the global factor is disproportionately associated with U.S. macroeconomic and financial conditions, due to the sheer size of the U.S. economy, the enormous importance of the dollar as a reserve and invoicing currency, and the role of U.S. government securities as safe haven assets.

On these bases, the importance of Federal Reserve policy also prevails.

Imports

Thus, in this discourse on spillovers, Mann focuses on the effect of U.S. monetary policy on U.K. macroeconomic and financial conditions.

While economic and financial conditions in the rest of Europe are certainly important to the UK, as is European Central Bank policy, the research on the global factor does not yield as large an impact, and the outlook for policy is more ambiguous at this point.

So today’s task is to estimate the likely effect of a tightening of U.S. monetary policy on the U.K. macroeconomy, and to consider alternative policy paths that U.K. monetary policymakers might consider in reaction.

For a foreign economy, this means capital outflows (or reduced capital inflows) and a depreciation of the currency.

As imports of goods become more expensive in foreign currency terms, this global financial channel will tend to have an inflationary effect on the non-U.S. economy.

To the extent that the depreciation makes U.S. exports more attractive on the world market, there may be a boost to exports that offsets the slowdown in global demand.

Inflationary pressures from tightening U.S. monetary policy have been documented especially in emerging market economies and have been found to be large and significant, but the relative price effect on export volumes appears to be mitigated by a number of factors, such as dollar turnover and membership in a multinational supply chain.

 

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