Economist El-Erian calls on the Fed to start "owning their mistakes"
Ryssdal: Let's get to that catch-up part. What would we look like right now if
El-Erian: Let me start by saying counterfactuals are inherently tricky. However, what do we know? We know that, had they not fallen into this cognitive trap of inflation being transitory, had they acted earlier, they could have hiked into a growing economy. And they could have avoided what is one of the most front-loaded hiking cycles in history.
Ryssdal: Explain that for the civilians in the audience, "front-loaded hiking cycles."
El-Erian: So, normally, you increase interest rates gradually and in a very measured fashion, because you want to assess the impact on the economy. If you are late — and the Fed has been very late — you have no choice but to move really quickly. To make it specific, this Fed has increased interest rates by .75% four times in a row. That is a record that is almost unheard of, including during the '70s and '80s, when we had a much bigger inflation problem. And they did that because they were so late and had to play catch-up. The problem with moving so quickly is that you don't have enough time to assess what the impact on the economy is.
Ryssdal: So, to that point,
El-Erian: It certainly has hit right now in the financial markets. It certainly has hit right now in the housing market. The problem is that, because the Fed waited for so long, the inflation challenge has shifted from the interest rate-sensitive sectors to sectors that are less interest rate-sensitive: services and wages. So yes, they are hitting, and yet the Fed is still behind the curve.
Ryssdal: Well, so what do you think the Fed should do?
El-Erian: Well, at this point, they have no choice but to go after inflation. That is their mandate. Because they're so late, there will be undue damage to the real economy — to employment, to livelihoods — that could have been avoided. Because they're so late, they've lost credibility. And because of that, we risk more financial instability.
Ryssdal: Let's talk about the Fed's credibility for a second. How do they — can they — get it back?
El-Erian: They can. They have to start by owning their mistakes, which they haven't done yet.
Ryssdal: Well, I mean,
El-Erian: That's absolutely right. And he has also acknowledged that there'll be pain, but what they haven't done — which is what the
Ryssdal: Do you think they just have? Like, I mean, is it as simple as bad forecasters and bad modeling among the 400 Ph.D. economists that they have?
El-Erian: So, I think they've ended up with four issues, and I think that's undebatable. One is failures of analysis and being cognitively trapped by the wrong characterization of inflation. Two: failure of communication. Their communication has been inconsistent. Three: Failures of forecasts. The forecasting errors have been not only significant but in the same direction consistently. And then the fourth one is failures of action. Even when they recognized, at the end of November last year, that inflation was not transitory, they didn't move fast enough.
Ryssdal: So to the future now, the Federal Reserve
El-Erian: So, there're several aspects to that question. Can they get us back to 2%? Yes, they can, but it would be at a massive cost to the real economy — that's not a great way to get to 2%. Second, if they were formulating the inflation target today, I doubt it will be 2%. I think most people agree it would be higher than that. And then third is even though there's good reason to have a higher target, this Fed that has lost credibility cannot be seen to be increasing the inflation target at a time when it has failed to meet its inflation target for so long. So the best we can hope for is, by the middle of next year, we've gotten to stable inflation of about 3% to 4%. They keep on telling us that they're gonna pursue 2% in the future, and society learns to live with a stable inflation rate that is not 2%. That is the new definition of a soft landing, now that we can't avoid a recession, unfortunately.
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