That’s what the Federal Reserve is doing.
Many Federal Reserve officials entered 2015 thinking they likely would start raising short-term interest rates by midyear. That idea got put on ice after a winter economic slowdown, partly attributed to the dollar’s rapid rise in previous months.
Fed officials say they won’t act until they see more labor-market improvement and are confident that inflation will rise toward their 2% goal.
The Fed’s mission, by statute, is to manage inflation and work toward full employment. It also has a requirement to maintain moderate interest rates, the subject here, but that’s largely subsumed in managing inflation. Inflation, for the last several years, has been held artificially low by the Fed’s holding interest rates artificially low and by this historically slow recovery and slow-growth economy in which we’ve been mired since the Panic of 2008.
The artificially low interest rates are not “moderate” by any stretch: they’re much too low and for entirely the wrong reason. Normal interest rates are in the 5%-7% range, and they’re not there because of Fed diktat, not because—properly—of market forces.
The inflation rate extant these last few years have been below the Fed’s target rate, and the most effective tool the Fed has is its interest rate management. Hence, interest rates must rise, in order to facilitate the inflation rate rising to the Fed’s preferred range (which isn’t a hard 2%, it’s a range from 2% to around 3-3.5%).
There are additional reasons rates need to rise. Borrowers are reluctant to borrow, for all the low rates, because the economy remains sluggish: there are too few buyers, whether consumers or other companies, because there’s too much uncertainty in the economy’s future. A robust, growing economy will take care of that. That requires the government generally get out of the way of the economy, and it requires the Fed to get out of the way of the market and, among other things, interest rates.
The other reason is that too many folks are dependent on fixed income instruments for their own income. These last six years of suppressed interest rates have depressed those folks’ income.
A strong dollar has nothing to do with any of this. The dollar is strong for two reasons: one is that we pay interest rates, low as they are, are higher for dollar denominated debt instruments than for other currencies. The other is that, sluggish as our economy is, it’s still doing better than much of the rest of the world. Neither of those are going to change anytime soon, but notice the key factor in both of those: the dollar’s strength is a reaction to those factors, not a driver. The dollar is strong in response to interest rates, a strong dollar is not driving rates.
The Fed needs to let rates rise and ignore the dollar. Full stop.
With moderate interest rates and inflation under control, the economy will have a chance to grow. From that, employment will improve, and not just the headline number; the labor participation rate will improve, too. The dollar will take care of itself.