The Fed sees a “flight to quality” as driving changes in global economic activity.

“Risk aversion,” “flight to quality,” and investing in dollar assets in general are a well-studied phenomenon, but their impact on economic activity in itself, both in the United States and around the world, has been relatively poorly studied. Economists at the US Federal Reserve System, the issuer of the dollar, suggest that the effect is underestimated: presumably, it, and not the Fed’s rate decisions themselves, is now the main mechanism of the global business cycle, and the actions of the US Treasury and the Fed only smooth out the consequences of this mechanism.

Among macroeconomists, the view that financial globalization and the ease of capital flows between key financial centers and peripheries has made “global risk aversion” a major factor driving global business cycles has become increasingly popular. At the level of national financial markets, the role of capital inflows and outflows is studied in sufficient detail – the “safe haven” around the world is strongly associated with US Treasuries and dollar assets in general. For each economy (which, with the exception of China, is usually significantly smaller than the US), the “harbour” appears to be more or less “bottomless”. All the more interesting is the work of Board of Governors economists published by the US Federal Reserve on September 29, who pose the question differently – what is the role of “risk aversion” in the US Federal Reserve’s monetary policy itself, in the business cycle in the US and in global business cycles?

For the rest of the world, two solutions are possible: a specific central bank either independently and for the sake of its own goals triggers with its decisions (for example, on the key rate) an increase (or decrease) in credit activity in its own banking system, or, in the case of high involvement of the economy in world trade, synchronizes these activities with the business cycles of major trading partners. The second scenario is more common, and because of this, the US business cycle is the main driver of global recessions and growth. It is obvious that the “flight to quality” due to the decline in global GDP should also influence the decisions of the issuer of the dollar – the US Federal Reserve: how strong is this influence and how independent is the Fed in actions affecting the American, and with it the world, business cycle?

The answer of Fed economists is paradoxical, although it is intuitively easily accepted: the shocks due to the global “flight to quality” are quite strong and spread so synchronously through the globalization of world financial markets that it is not necessary to say that it is the Fed that controls the dynamics of world GDP through the movement of the key rate. In contrast, the flight to quality should probably be considered the main driver of the global business cycle and the most important driver of the US business cycle.

The size of the US economy relative to its trading partners is such that the impact on it is weaker than on any other jurisdiction. However, the impact of the “flight to quality”, which reduces global economic activity and global inflation, widens corporate borrowing spreads and strengthens the US dollar, is also significant at the level of the US economy. At the same time, the Fed’s actions, at least in 2008–2018, can be viewed as a rational response within the monetary policy framework to global capital inflows and outflows to the United States, explained by the dynamics of the global business cycle and exogenous shocks, from wars and surges in foreign policy tensions (i.e. at the limit – expectations of wars) to natural disasters.

Technically, the work of the authors of the Federal Reserve, entitled “Global Flight to Quality, Business Cycles and the Dollar,” is needed to assess the capabilities of national (outside the US, but partly there) regulators independently, without taking into account the global business cycles of decline and rise in business and credit activity, cope with financial instability in your jurisdiction. Nevertheless, the main conclusion that emerges is even broader – the global business cycle, in essence, is not controlled by anyone, and the role of the US Federal Reserve in this process also depends on the course of events in world history, which cannot be controlled.

Dmitry Butrin