A strong dollar is restraining U.S. inflation and exports and has already delayed the Federal Reserve's first interest-rate increase, but the U.S. economy is riding out the effects fairly well and it "may be appropriate" for the Fed to begin raising rates next month, Fed Vice Chairman Stanley Fischer said Thursday.
"It's clear that the appreciation of the dollar and the accompanying foreign weakness has been a sizable shock, but the U.S. economy appears to be weathering those shocks reasonably well, notwithstanding their large effects on certain sectors of the economy heavily exposed to international trade," Mr. Fischer told a Fed research conference in Washington. "Monetary policy has played a key role in achieving these outcomes through deferring liftoff relative to what was expected a little over a year ago."
He noted Fed officials have lowered their projected path for the benchmark federal-funds rate since the dollar began its ascent in mid-2014, in effect holding rates lower than they otherwise would have been, "and in that sense we were running an expansionary monetary policy" to offset the effects of the dollar.
In September, the Fed decided to delay raising short-term interest rates that have been pinned near zero since December 2008. The dollar strengthening against other major world currencies was one worry on officials' minds; their Sept. 17 policy statement said that "recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term." That line was dropped from the Fed's next statement on Oct. 28, a sign those worries had faded somewhat.
Mr. Fischer noted Thursday that the Fed's latest policy statement "indicated that it may be appropriate" to raise rates at the coming Dec. 15-16 meeting, "although the outcome will depend on the [rate-setting Federal Open Market] Committee's assessment of the progress—realized and expected—that has been made toward meeting our goals of maximum employment and price stability. But of course, as policy makers, we have always to be vigilant of the possibility of events unfolding differently than we expect. We've still got another month-plus of events to unfold, and we have to be ready to react to the actual events and not the ones we might prefer to have."
Mr. Fischer said the dollar's rise since July 2014 has been large, though not unprecedented historically. He said the appreciation has been partially driven by a decline in foreign interest rates relative to U.S. rates, as well as "heightened concern about the global outlook and an associated decrease in investor risk tolerance."
A stronger dollar reduces U.S. exports by making them more expensive for foreign customers, restraining overall economic growth, and Mr. Fischer said the drag may persist well into next year. A stronger dollar also puts downward pressure on import prices, but he described the effect on U.S. inflation as more muted and transient than the impact on economic growth.
Forces that have been holding down inflation, such as the dollar's rise and declining energy prices, should begin to fade next year, he said. U.S. inflation has undershot the Fed's 2% annual target for more than three years, and Fed officials have said they want to be "reasonably confident" it will rise back to 2% before they begin to raise rates.
Mr. Fischer isn't the only official at the U.S. central bank weighing the effects of the dollar on the U.S. economy and the outlook for monetary policy. Fed governor Lael Brainard, in a speech last week, warned that "the feedback loop between … expectations of divergence between the United States and major trade partners and financial tightening in the United States means that material restraint to U.S. conditions is already in place." She added, "Looking ahead, a further downgrade of foreign growth prospects could pose downside risks to the U.S. outlook."
Normally, Ms. Brainard added, "policy in the United States could ease smoothly in response to signs that spillovers from developments abroad were restraining activity or inflation in the United States. But with policy rates in the United States at the lower bound, the ability to offset spillovers from adverse developments in foreign economies with conventional policy is constrained and is likely to be so for some time, and this asymmetry in risk management suggests greater caution than normal."
Mr. Fischer has previously said he expected the Fed will raise short-term interest rates by the end of 2015, while Ms. Brainard in October called for "watching and waiting" before raising rates.
Write to Ben Leubsdorf at ben.leubsdorf@wsj.com
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