Euro coin and United States dollar bill. Onny Carr/Flickr

The Great Policy Divergence

Over the next few weeks, the US Federal Reserve is expected to raise interest rates, while the European Central Bank doubles down on monetary stimulus. Although both central banks are pursuing legitimate domestic agendas, there are few mechanisms to manage the international repercussions of this policy disparity.

WASHINGTON, DC – Over the next few weeks, the US Federal Reserve and the European Central Bank are likely to put in place notably different policies. The Fed is set to raise interest rates for the first time in almost ten years. Meanwhile, the ECB is expected to introduce additional unconventional measures to drive rates in the opposite direction, even if that means putting further downward pressure on some government bonds that are already trading at negative nominal yields.

In implementing these policies, both central banks are pursuing domestic objectives mandated by their governing legislation. The problem is that there may be few, if any, orderly mechanisms to manage the international repercussions of this growing divergence.

The Fed is responding to continued indications of robust job creation in the United States and other signs that the country’s economy is recovering, albeit moderately so. Also conscious of the risk to financial stability if interest rates remain at artificially low levels, the Fed is expected to increase them when its policy-setting Federal Open Market Committee meets on December 15-16. The move marks a turning point in the Fed’s approach to the economy. In deciding to raise interest rates, it will be doing more than simply lifting its foot from the financial-stimulus accelerator; it will also be taking a notable step toward the multiyear normalization of its overall policy stance.

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