In recent months, a frightening narrative has spread in international financial circles: rising U.S. interest rates are strengthening the dollar, forcing the economy to devalue the currency and raise the cost of imports, which are already struggling with soaring energy and food prices.
To contain soaring inflation, foreign central banks must tighten their own monetary policies further, pushing the world into a global recession. Moreover, higher U.S. interest rates and a stronger dollar are putting particular pressure on emerging market economies (EMEs), which must buy dollars to pay off their dollar-denominated debts with an ever-cheaper local currency, The Hill writes.
There is more than a grain of truth in these concerns. The rising dollar is one of the channels through which a tightening of U.S. monetary policy helps cool the economy, and that inevitably involves exporting some of our inflation to other countries. It is also true that historically tighter Fed policy has meant bad news for emerging markets: falling currencies, rising credit spreads, and devastating capital outflows.
These effects were especially noticeable when the Fed was responding to rising inflation (e.g., in the early 1980s) rather than to robust U.S. economic growth (mid-2000s).