I went to an event at New America yesterday where Tom Gallagher, Senior Managing Director at the International Strategy and Investment Group, put forward an idea I hadn't heard before regarding the current debate over whether or not the Fed is making a mistake by setting interest rates too low and setting off inflation. Gallagher's take on this is that loose monetary policy is appropriate given the current state of the U.S. economy, but that the problem is that developing countries, especially China, are loathe to let their currencies appreciate too much against the dollar. Consequently, they wind up "importing" a good deal of American monetary policy even though they're not in slowdown conditions. And the upshot is inflation over there which then, via the global commodities markets, becomes exported to the United States.
The ideal response to this, he said, would be for Bernanke to keep our monetary policy loose but for other countries to tighten. But if that doesn't happen, we may be forced into a situation where we need to tighten our monetary policy in order to halt inflation even though really it would be better to keep things loose. Long story short, some financial diplomacy is badly needed in order to help us avoid an unfortunate macroeconomic policy conundrum.
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