Specifically, the Fed suggested that the rapid pace of deceleration in global growth, combined with a substantial increase in the value of the dollar, could affect its outlook for the recovery in the U.S., specifically the inflation outlook, in which "price stability" comprises one-half of the Fed's dual mandate.
Put another way, despite substantial improvements in the labor market and a move toward fuller employment, weak global growth and a stronger dollar could drive inflation down, and farther away from the Fed's stated 2-percent target.
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The world is again dealing with the threat of deflation, as Europe, including Germany, its strongest economy, is on the brink of a continental recession. Japan may also fall back into recession, while Brazil, Eastern Europe and Russia, are, effectively, already there.
The concern is not just that weak global growth will dampen U.S. exports, or that a strong dollar with further hurt the export sector of the economy and cut into multinational profits. The strengthening of the dollar can lead to imported deflation, touching off another down leg in the U.S. … with the rest of the world sneezing, the U.S. catches cold.
Indeed, over the weekend, Stanley Fischer, the Fed's new vice-chairman, indicated that these concerns could lead to a delay in the Fed's anticipated rate hikes.
Now, here's where the pundits start to run ahead of the Fed.
Some are suggesting that the Fed could launch yet a fourth round of quantitative easing, despite nary a mention of this from even the most dovish Fed officials.
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The Fed has always maintained that the end to unconventional measures remains contingent upon a cooperating economy, one that meets both goals of the central banks … maximum sustainable employment and stable prices.
And while some claim the Fed is moving the goal posts by introducing new variables, like global economic weakness and a stronger dollar, into their models, they are important variables that require consideration.
Having said that, the Fed, even its most dovish members, may be less than enthusiastic about launching another round of QE.
In fact, if domestic growth is threatened by these other factors, I believe the Fed would examine how other unconventional tools could be used to stimulate growth at home and ward off an external threat.
Specifically, the Fed could stop paying interest on excess reserves (IOER), held by banks, at the Fed.
Ironically, this is the very tool the Fed would use if it were ready to tighten policy, by paying banks more to keep their excess reserves in the vaults of the central bank.
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Stopping those payments could force the banks to pull their excess reserves and find more profitable uses for the funds, like making more loans, assuming credit restrictions are relaxed, thus stimulating economic activity.