Fed Is Restricted by Its Congressional Mandate
Letter to the Editor

Resident Fellow
Desmond Lachman
Your editorial suggesting that the Federal Reserve should raise interest rates to address the global inflation problem ("Fed cannot ignore global inflation", June 26) overlooks the fact that the Fed is restricted by its dual congressional mandate to pursuing U.S. price stability and U.S. employment and economic growth. It also ignores the fact that the world is not an optimum currency area, which would imply that, under a fixed exchange rate system, one should not expect a single Fed interest rate policy to meet simultaneously the needs of the U.S. and of the emerging Asian and Middle Eastern countries.

In a world of capital mobility, an important part of any solution to the Asian and Middle Eastern inflation problem must be a move by the countries of those regions towards greater exchange rate flexibility. Such a move would allow those countries to regain monetary policy independence from the U.S. and to set domestic interest rates at levels appropriate for their economies' fight against inflation.

Greater exchange rate flexibility in Asia and the Middle East would also be helpful in addressing the global payment imbalance problem and it would relieve the euro of having to bear the full burden of the dollar's adjustment. It is far from obvious that greater exchange rate flexibility in Asia and the Middle East would necessarily lead those countries to start selling dollars in a manner that would provoke a dollar crisis.

The countries of Asia and the Middle East would be making a grave policy mistake in persisting with quasi-fixed exchange rate policies and in waiting for the Fed to raise interest rates for their benefit. This would seem to be especially the case at a time when the U.S. is facing the real risk of a prolonged and nasty recession under the weight of its worst housing and credit market busts in the post-war period and of a major oil price shock on a scale of that in 1979.

Desmond Lachman is a resident fellow at AEI.

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