“Monetary policy is the wrong tool”: Why economist El-Erian thinks the Fed is making a mistake
During his virtual speech at the Kansas City Federal Reserve’s annual Jackson Hole Economic Policy Symposium, Fed Chair Jerome Powell said he believes the central bank’s policy is “well positioned” for this economic moment. Economist Mohamed A. El-Erian, the president of Queens’ College at the University of Cambridge and former CEO of Pimco, disagrees.
“Marketplace” host Kai Ryssdal spoke with El-Erian about his thoughts on the latest news from the Federal Reserve and the state of the economy’s recovery. The following is an edited transcript of their conversation.
Kai Ryssdal: We talked in June, and you made your case that the Federal Reserve was making a policy mistake and providing so much support to the economy for so long. And here we are six weeks, two months later, [and] the economy has obviously changed with the delta variant. Chair Powell made the big speech on Friday. Are you more or less concerned than you were a weeks ago?
Mohamed A. El-Erian: I am as concerned, not because I don’t think the economy needs help. But I think monetary policy is the wrong tool. And other Fed officials have come out and said explicitly it is not clear that the current policy approach is actually helping the economy.
Ryssdal: Yeah. What do you make, not to get into the Kremlinology of the Federal Reserve, but a number of senior Federal Reserve regional presidents have come out and said, “You know what, it’s time to start cutting back on this support sooner or later.” What do you make of that?
El-Erian: Yeah, we are seeing the center of gravity within the [Federal Open Market Committee], which is the Federal Reserve policymaking committee, shift. Shift towards, “Let’s ease of this incredible stimulus that was introduced in the midst of the COVID-19 emergency.” Now, why are they shifting? A few reasons. One is getting evidence that the inflation that we are all experiencing is likely to be more persistent and higher than they thought. Secondly, there’s very little evidence that suggests that this is helping the economy. And thirdly, it continues to decouple asset prices, markets from the real economy, which makes inequality worse and increases the risk of financial instability.
Ryssdal: What do you suppose you and some of those regional Fed presidents are looking at that either Chair Powell isn’t seeing or is seeing and choosing to stay the course anyway?
“It’s a balance of risk argument”
El-Erian: Well, clearly, Chair Powell has evolved because he came out on Friday and said that lots of ground has been covered to reach the maximum employment objective and that the inflation objective has been met. So clearly, he sees things evolving. I think what’s different is how you see the balance of risk. I can’t speak for others, but I can tell you, I see it as two sided, that there’s a risk that we may end up doing more harm than good. Whereas the chair is still seeing it more as one sided. So I think it’s a balance of risk argument, rather than what’s actually happening on the ground, because what’s happening on the ground is very clear. We have higher and more persistent inflation. And we’ve created 1.9 million jobs in just two months.
Ryssdal: And this balance is that Powell thinks the risks are going to fade and you think they’re going to continue and accelerate perhaps?
El-Erian: He believes strongly that inflation is transitory, meaning it is both temporary and reversible. I am saying, “You know what, we have to be more humble about the inflation dynamics. There’s a likelihood that inflation will be more persistent. That’s No. 1. And second, his read of history suggest to him that it’s better to make the mistake of underreacting to inflation than overreacting. Whereas my weight of history is “Let’s look at both these likely mistakes and make sure that we strike the right balance.”
Ryssdal: You wrote in a Bloomberg piece out today, I think, about Chair Powell working toward or trying to wordsmith his way, I suppose, to constructive ambiguity. That is to say, if I can interpret, having a little bit both ways?
“Constructive ambiguity”
El-Erian: Correct. So he acknowledged what other people have been seeing, but then he packaged it in a very dovish packaging. And that’s why the markets got all excited, and we got yet another record high. So clearly, the financial markets love this liquidity paradigm. But he, Chair Powell, packaged it by saying even though these things are happening, he said two things. One is there’s still ground to cover. And two, only time will tell whether the 2% inflation will be sustainable. This is basically giving himself optionality. He is basically trying to have constructive ambiguity. However, the market, at some point, is going to insist on clarity.
Ryssdal: All right, well since Chair Powell, despite our repeated invitations, has not yet decided to come back on the program, and I do have you here, let me try to nail you down on timing. How long do you think it will take before we have a sense of of who’s right?
Looking for 2% inflation next year
El-Erian: So I think towards the end of the year we’re going to get the answer to one important question: Is inflation higher and more persistent than the Fed expects? The Fed is looking for it to start coming back down and have clear evidence that we will be within 2% next year. On the employment front, it’s trickier. This labor market is behaving in a rather strange way. We know that we’ve got 800,000 jobs to make up from before the pandemic. But we also know that there’s a record level of vacancies, 10 million. So something is not quite working in the labor market. That, I think, is going to take a little bit longer to sort out.