Is It Time For El-Erian To Be A Fed President?

Economic advisor Mohamed A. El-Erian discusses the Fed's goals and the methods to achieve them. He has a much different take than the current set of groupthink members.

Feasible vs Desirable

Please consider The Fed Must Weigh What’s Feasible Versus Desirable, a Bloomberg op-ed by El-Erian.

Reacting to growing indications of a moderating recovery, some economists and Wall Street analysts are pushing the Federal Reserve to provide even more stimulative “forward guidance” at its policy meeting this week. The Fed is easily able to do so, and not only under the auspices of its long-established operating paradigm of data dependency and insurance mindset. Last month’s framework revisions have structurally built in more flexibility by allowing for a higher inflation target in periods such as now.

Yet what is operationally feasible is not so clearly desirable. The more the Fed goes down this road on its own, the greater the risks to economic well-being and its own credibility. Also, the challenges are not limited to domestic problems.

Credibility? What Credibility?

The Fed has missed targets on inflation, growth, and issues related to unemployment for many decades.

It has relied on models proven not to work such as the Phillips Curve and inflation expectations.

The Fed calls forward guidance a primary tool.

But forward guidance is little more than a proven opportunity for hedge funds and market makers to front run Fed operations with leverage.

The result of this incredible mess has been three economic bubbles in succession, with increasing amplitude each time.

Credibility aside, El-Erian comes up with five issues with the path the Fed is taking.

El-Erian's Five Issues 

  1. Monetary policy has repeatedly shown limited effectiveness in countering the negative impact of the economic pressures emanating from the Covid-19 shock. This is especially true given that what policy can achieve – ensure smooth market functioning – is not an issue.
  2. Even looser monetary policy is likely to result in further disconnecting financial markets from the real economy (the issue of prosperous Wall Street versus struggling Main Street). This could easily amplify the view that the Fed is aggravating inequality. Indeed, many signs of excessive financial risk-taking are already flashing yellow or red on the back of the continuously reinforced market notion of a deep, always in-the-money “Fed Put.”
  3. The threat of a surge in inflation in one to two years cannot be ignored as easily as in the recent past. The data are picking up increased evidence of uneven higher price formation.
  4. Greater Fed activism could well contribute to delays in Congressional actions on economic policy initiatives. Specifically, Republican lawmakers and the White House are less likely to seek a compromise with Democrats if the stock market continues to do well. And the closer we get to the November election, the louder the political blame game gets, and the smaller the window for compromise.
  5. Loose Fed policy is pushing yet another round of flighty foreign portfolio capital to them in search of higher returns (or, more accurately, escaping very low returns in the U.S. and other advanced countries). This additional turn in the “feast-famine-feast” foreign capital phenomenon for emerging markets comes at a time of higher debt, reduced policy flexibility and increasing probability of a “paradigm of non payment.”
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