Mohamed A. El-Erian: The Fed is failing in four ways

Mohamed A. El-Erian, Bloomberg Opinion
8 hrs ago

Global economy watchers and market participants will be paying a lot of attention next week to how the Federal Reserve describes the U.S. economic outlook, to the magnitude of its interest rate increase and whether it changes the pace of its balance-sheet contraction. Yet for the well-being of the U.S. and global economy, the answer to these questions is less important than whether the Fed shows seriousness about fixing four failures that continue to fuel one of the worse policy mistakes in decades: Failures of analysis, forecasts, response and communication.

Let us first dispose with what seems to interest economists and markets the most right now.

On the economic outlook, the Fed will acknowledge that, once again, inflation has proved to be higher and more stubborn than projected and that, despite some signs of weakness, the U.S. economy remains in a “good place.” With that, it is likely to again lift rates by 75 basis points and leave unchanged its previously announced plans for quantitative tightening.

This will come as a relief to those worried that the Fed, playing a desperate game of catch-up, would raise rates by 100 basis points and worsen what is already an uncomfortably high risk of tipping the U.S. economy into recession. Yet such relief will again prove fleeting unless the Fed also regains policy credibility by addressing its four persistent failures.

The first is one of analysis. The Fed has yet to make the comprehensive analytical shift from a world dominated for years by deficient aggregate demand to the current one where deficient aggregate supply plays an important role. Its monetary policy approach is either still formally governed by the “new framework” adopted last year that is no longer suitable and should be publicly discarded or governed by no framework at all, thereby leaving the U.S. and global economy without a much-needed anchor. The result of this is a central bank that continuously struggles to properly inform and influence economic agents, that consistently lags behind markets rather than leads them, and that could easily fall prey to the even more catastrophic policy mistake of returning to the 1970s trap of “stop-go” policies.The longer the Fed resists the overdue analytical pivot, the more its inflation and growth forecasts will continue to miss the mark, exacerbating the second failure. For the last few quarters, such projections have been quickly and correctly dismissed as unrealistic by a wide range of economists, market analysts and, even more unusual, former Fed officials. This matters even more now that the U.S. economy is showing signs not just of weakening but also of flirting with a recession.