Paul Krugman says the dollar's dominance means the Fed will do more damage to the global economy than other central banks in fighting inflation

• Dollar dominance means the Fed has an outsized impact on the global economy, Paul Krugman warned.
• Global trade and debt is still largely denominated in dollars, giving the Fed a far-reaching influence. 
• But that likely won't stop the Fed from hiking rates to control inflation, which could spell trouble for the global economy.

The Federal Reserve has signaled it will stick to its hawkish monetary policy until inflation is tamed, but the dominance of the US dollar also means the US central bank can do a lot more damage to the global economy than other central banks, top economist Paul Krugman warned.

The dollar's impressive rally this year has largely been in part to the Fed's tightening of monetary policy. The US Dollar Index, which values the greenback against a basket of currencies, rose 13% to 109 at the market close on Friday, a climb that comes as rival currencies plunge this year. 

But that's not the full story, Krugman said in an op-ed for the New York Times on Monday. Although the greenback's rise is partly due to Fed tightening, other central banks, such as the ECB, have hiked interest rates by a similar amount. But it's the dollar that's driven the euro down, not the other way around.

Krugman said that's largely because of the dollar's history as a dominant currency, which makes it hard to topple in the foreign exchange market. Although the US now accounts for around 25% of the world's GDP – down from 40% in 1960 – it's still more convenient for global trade to be conducted in dollars.

"Once a currency has established global dominance, that very dominance tends to become self-perpetuating. Making transactions in dollars is cheaper because so many other people are using dollars; borrowing in dollars tends to be cheaper because a lot of world trade is invoiced in dollars, and the low cost of financing encourages dollar invoicing." Krugman said.

That trend is also seen in debt and equities: most of the world's debt is in US dollars, and US stocks tend to be more accessible to international investors than European stocks, as eurozone equities are broken up by country.

It explains the greenback's outsized influence on other countries' balance sheets – and it's led some economists to argue that the Fed needs to consider the health of the global economy when issuing rate hikes. 

But Krugman doubts that will be a possibility until central bankers feel inflation is under control:

"I don't think the Fed will listen – yet. Federal Reserve officials are still deeply worried about the possibility that high inflation will get entrenched in the US economy, and that concern will dominate everything else until there are clear signs that underlying inflation is coming down," he warned.

The Fed is expected to issue another rate hike this week of 50-75 basis points, and Fed chair Jerome Powell has said the central bank intends to keep hiking "until the job is done".