Will more reserve currencies strengthen the international monetary system? My answer can be summed up in one word: “yes.”

This greater degree of monetary accommodation seems appropriate given the adverse effects on U.S. aggregate demand coming from the rise in the dollar, an associated weakening of foreign economic prospects, and other developments that have restrained spending and kept inflation undesirably low.

"There are certain aspects of the U.S. outlook that are encouraging. The improvement in the labor market has been extremely steady," said Brainard, who last month argued that the Fed should hold off until it was clear that a global slowdown would not push the U.S. recovery off course.

"There are still margins of slack in the U.S. labor force but we've certainly made some progress there," Brainard told a conference organized by the European Central Bank.

But wage growth has not been in line with the rise in employment, Brainard said, calling this trend puzzling. She noted that core inflation has remained below target and needed to be carefully monitored.

Brainard also singled out the dollar's appreciation over the past year, which has led to a "material" tightening of conditions.

"If you look at the cross currents, and one measure of those is the extent to which the currency has appreciated as expectations of divergence have grown, we have seen about 15 percent broad real appreciation in the exchange rate over the past year, which is a drag on prices and exports. We've already seen by that measure some material tightening in the United States."

WINKLER: Five-year bond yields suggested for expected inflation have turned positive for the first time in more than three years. Is the Fed ready to accept this tightening of financial conditions?

DUDLEY: Well I think we evaluate what the economic outlook is and what's happening to financial conditions. And obviously we don't control financial conditions. It also depends on what's happening in the global economy. But we definitely take that on board. I think when I - the dollar it has appreciated a bit over the last few months, not by a significantly (inaudible), but obviously that does factor in terms of our economic forecast. If the dollar were to strengthen a lot it would have consequences for growth. We would have poorer trade performance, less exports, more imports. And if the dollar were to appreciate a lot it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account.

...

I think that the dollar partly reflects the relative performance of the U.S. economy relative to performances in other countries, and in that case that you could sort of understand what we're seeing. I think from our perspective we don't care about the dollar per se. In other words that's not a goal, independent goal of policy. Our goal policy is maximum sustainable employment and two percent inflation. Obviously as the dollar moves that affects the appropriateness of a given monetary policy to achieve those objectives. And we certainly take it on board just like we take on board what's happening to the stock market, what's happening to the bond market, what's happening to credit spreads, what's happening to credit availability. All those factors sort of drive our assessment of what's happening to financial conditions. And then that influences our economic outlook. And then that in turn then influences the monetary policy response.

WINKLER: Five-year bond yields suggested for expected inflation have turned positive for the first time in more than three years. Is the Fed ready to accept this tightening of financial conditions?

DUDLEY: Well I think we evaluate what the economic outlook is and what's happening to financial conditions. And obviously we don't control financial conditions. It also depends on what's happening in the global economy. But we definitely take that on board. I think when I - the dollar it has appreciated a bit over the last few months, not by a significantly (inaudible), but obviously that does factor in terms of our economic forecast. If the dollar were to strengthen a lot it would have consequences for growth. We would have poorer trade performance, less exports, more imports. And if the dollar were to appreciate a lot it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account.

...

I think that the dollar partly reflects the relative performance of the U.S. economy relative to performances in other countries, and in that case that you could sort of understand what we're seeing. I think from our perspective we don't care about the dollar per se. In other words that's not a goal, independent goal of policy. Our goal policy is maximum sustainable employment and two percent inflation. Obviously as the dollar moves that affects the appropriateness of a given monetary policy to achieve those objectives. And we certainly take it on board just like we take on board what's happening to the stock market, what's happening to the bond market, what's happening to credit spreads, what's happening to credit availability. All those factors sort of drive our assessment of what's happening to financial conditions. And then that influences our economic outlook. And then that in turn then influences the monetary policy response.

I gave some remarks on this at a London event for Mervyn King’s retirement. And appropriate of today’s discussion, I used historical examples. I made a distinction of during the 1930s, during the Great Depression, as countries left the gold standard, their currencies temporarily depreciated relative to other countries, and they had a temporary trade advantage because of that; but over time, as all the countries left the gold standard, exchange rates kind of normalized, kind of went back to where they started from, but nevertheless the whole world was nevertheless much better off because there was a global monetary expansion which was desperately needed at that time, in the 1930s.

So that was a positive sum game. It was a situation in which everybody gains because the benefits of — in that particular context, the benefits of growth-enhancing domestic policies spilled over into other economies.

I contrasted that with the Smoot-Hawley tariff, which was more of a zero sum game, where the — or even negative sum, because what was going on there was that each country was trying to divert trade in its own favor at the expense of its trading partners; and as that activity continued and as reprisals and payback continued, actually it destroyed the global trade pattern and was very costly to everybody.

So, what has this got to do with your question? I’m sure you’re wondering. (Laughter.) What it has to do with today is that it’s one thing to use trade or other kinds of interventions to divert — to artificially weaken your currency or otherwise to divert exports to your own producers at the expense of other countries. That’s a very different thing from a situation where countries are using monetary policy appropriately to achieve domestic growth, domestic reflation and that growth spills over and helps the economies of other countries as well. So I think that’s very much the difference, that the exchange rate effects and the currency effects are really secondary. What’s important is that each country provide the necessary monetary accommodation or fiscal accommodation to achieve — to achieve its potential output.

Finally, although it’s not our main intention, these unconventional policies have also had an effect on the dollar versus foreign currencies. When interest rates in the United States fall relative to rates in other countries, the dollar tends to decline as money flows to foreign markets with higher returns. One estimate is that a $600 billion program like QE2 causes the dollar to fall by roughly 3 or 4 percent. That helps stimulate the U.S. economy by making American goods more competitive at home and abroad.

“We face a very real risk of having formidable competitors to the dollar in the sweepstakes for sovereign investment,” Fisher said today in remarks prepared for a speech in La Jolla, California. “As Chinese policy makers lay the groundwork for the continued internationalization of the renminbi, our nation’s fiscal authorities must bear in mind that there may one day be viable alternatives to the dollar and U.S. Treasury debt.”

We need a system characterized by more open capital accounts, flexible exchange rates, and independent monetary policies. Open capital accounts, supported by appropriate financial supervision and regulation, channel savings to their most productive uses, thereby enhancing welfare. Exchange rate flexibility improves domestic macroeconomic management, allowing countries to pursue independent monetary policies tailored to their individual needs, and limits unwelcome spillovers to other economies. Such a system can also flexibly adapt to changing economic and financial realities as countries develop, technology progresses, and shocks buffet the global economy.

Our current international monetary system does not yet fulfill these objectives.

Dallas Fed President Richard Fisher, speaking to reporters after a townhall-style event with local business leaders in this central Texas town, said he wants the dollar to be more than "the best horse in the glue factory."

Notably, in recent months, some officials in emerging market economies and elsewhere have argued that accommodative monetary policies in the advanced economies, especially the United States, have been producing negative spillover effects on their economies. In particular, they are concerned that advanced economy policies are inducing excessive capital inflows to the emerging market economies, inflows that in turn put unwelcome upward pressure on emerging market currencies and threaten to create asset price bubbles...

To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth--both in the short term and in the longer run--and higher interest rates, which reflect differences in policy settings as well as other forces....

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country's producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

"The purpose of it is not to push down the dollar. This should not be regarded as some sort of chapter in a currency war."

"We have no desire to see inflation higher than the 2%,-or-slightly-below range. We're not doing price level targeting or raising our inflation goal."

"If I were to continue to be concerned about the outlook and thought that further purchases could work, then I would have to seriously consider that step."

Excerpts from a Wall Street Journal interview

"The weakening dollar factors into our sense of economic growth and inflation," Richmond Federal Reserve Bank President Jeffrey Lacker told an audience after giving a speech here.

"In the current environment, the extent to which it has added to inflationary pressures, particularly with commodity and energy prices, is definitely a prime risk on our minds.

"What we're going to do about it is conduct policy the way we always have, which focuses on domestic inflation," he said.

...

Lacker, voicing long-standing views of the Richmond Fed and many others in the economics' profession about the unwelcome consequences of interfering with markets, made plain he would be reluctant to support {foreign currency intervention}.

"I think foreign currency intervention by central banks is a mistake...as a matter of general policy," he told reporters after the speech.

As reported by Reuters

I would never take intervention off the table -- or any policy tool off the table.

One of the first rules you learn if you're working for the Federal Reserve is to leave comments about the dollar to the Treasury. I'm more
than happy to adhere to that rule ... Having said that, I'd be careful about mistaking correlation and causation. Just because energy prices and the dollar seem to move together -- pick any two prices or [indistinct] you happen to be interested in -- just because they happen to move together doesn't mean there's a causation there.

From Q&A as reported by Market News International