Editor’s note: Mohammad A. El-Erian is president of Queen’s College, University of Cambridge, Renee Kearns Professor at the Wharton Business School, senior fellow at the Lauder Institute, and advisor to Allianz and Gramercy. He serves on the boards of Barclays, NBER and Under Armour. The opinion expressed in this commentary is his own.
This week, it will become increasingly clear to economists and policymakers around the world that the Federal Reserve is in a Catch-22 situation of its own making. Compelled by concerns about high and persistent inflation, the Fed will likely go down in history as it has raised interest rates by the same amount in three consecutive policy meetings. But because it is doing so in a weak economy, it will face criticism not only for domestic economic well-being, but also for global growth.
The unfortunate situation the Fed is in — damned if you do, and damned if you don’t — is an example of a deeper problem. While a “soft landing” for the economy was possible, (that is, reducing inflation without hurting the economy too much), the Fed now finds itself woefully far removed from the world of “first-best” policymaking. In other words, instead of taking highly effective, timely and well-targeted measures to combat inflation, the Fed has ended up in a world where virtually all of its policy actions can cause significant collateral damage and unintended adverse consequences. Many politicians, companies and households think of the Fed as part of the problem and not part of the solution.
What is likely to be a record third 75 basis-point increase comes against a backdrop of damaging cost-of-living increases that are widening in scope and, making matters worse, becoming more embedded in the fabric of the economy. Headline inflation, currently 8.3%, may be falling, but the core rate, which excludes more volatile categories like food and gas, is still rising. And it’s the latter, currently at 6.3%, that measures the breadth and likely persistence of inflation.
Still, for almost all of last year, the Fed has consistently played down inflation threats. Meanwhile, the economy continues to be conditioned to operate under zero interest rates; And markets continue to be comforted by repeated Fed interventions to offset declines in equity prices (so-called “Fed puts”).
But until late November of last year the Fed stopped short of assuring us, repeatedly, that inflation was “transient”. Just a few months ago, it was still pumping Liquidity When inflation is rising rapidly in the economy.
Now, the Fed realizes it’s too late to react. By allowing inflation to become more embedded — or, as a chair Jerome Powell The Fed would have to be much more aggressive now if it were to respond in a timely manner, the Fed said last month, “in order to spread through the economy.” The Fed must avoid another blow to its already damaged reputation and policy credibility.
Instead of leading the markets in tackling inflation, the Fed has been forced to follow them. Until Powell’s hawkish pivot last month Jackson Hole Economic Symposium, it was forced to repeatedly revise its policy guidelines to make it more consistent with what the markets were signaling Combined with seemingly endless one-way revisions to key economic forecasts (high inflation and low growth), this has unfortunately changed the Fed’s economic and monetary role from trusted leader to scrambling laggard.
Yet, because it has been so late to react, the Fed will be hiking aggressively in a weak domestic and global economy. Thus, a growing number of economists warn that the Fed will lead the United States into recession; And a growing number of foreign policymakers are complaining that the world’s most powerful and systemically important central bank is pulling the rug out from under an already fragile global economy. This is a far cry from the Fed’s much-celebrated role in helping to avert the highly damaging global depressions of both 2008-2009 and, more recently, the 2020s.
This week’s policy action could end up in three different parts of our economic history books: the first time the Fed has raised rates 75 basis points in three consecutive meetings; Another element of the central bank’s biggest policy mistake in decades; And an unusual example is a developed country’s central bank finding itself in a policy hole more familiar to some of its peer institutions in the developing world.