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
- 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.
- 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.”
- 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.
- 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.
- 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.”
What About Inflation?
I agree with El-Erian on points 1, 2, 4, and 5.
The problem with 3 is how to define it. Inflation is running rampant already if one considers asset prices and junk bond bubbles as key components.
Moreover, the mere substitution of actual home prices in the CPI instead of owners equivalent rent would show inflation is already hot.
The Fed's focus on "Consumer Inflation" rather than "Inflation" is the problem.
When asset bubbles burst, they bring about debt deflation which is what the Fed should be worried about but isn't.
BIS Deflation Study
The BIS did a historical study and found routine deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.
Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.
The inflation that El-Erian see's in the future is now, and the future will be another bout of deflation.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
Breath of Fresh Air
Overall, however, El-Erian provides a much needed breath of fresh air.
He has a far better grasp of things than Jerome Powell or any of the Fed presidents all clamoring to let inflation run hot to make up for inflation allegedly running too low.
El-Erian made a Tweet the other day in which he said "The Fed should do nothing."
I replied that there should not be a Fed in the first place.
Feasible vs Desirable Take II
It would be highly desirable to not have a Fed at all. Instead, we should have 100% gold-backed money, end fractional reserve lending, and let the market (not a group of clueless central planners) set interest rates.
However, It is not be feasible right now to get rid of the Fed. It is more feasible to end Fed group-think mentality.
On those grounds, I support gold-advocate Judy Shelton for the Fed as discussed in Controversial Gold Advocate Advances for a Fed Appointment.
Right now, she may be a vote or two short.
The Fed Should Do Nothing
El-Erian was more correct than not when he Tweeted "The Fed Should Do Nothing", a Tweet now deleted. In a private exchange he says he does not remember deleting it.
Three successive economic bubbles clobbering the middle class with the Fed bailing out the banks and the wealthy provides ample evidence of the need to end the Fed.
Doing nothing would be a huge step in the right direction.
In the spirit of diversity and feasibility over what's truly desirable (ending the Fed), I support the appointment of El-Erian (or anyone "do nothing" views) to to the Fed.
A Fed chair appointment would be even better.