Will the Fed make its third policy mistake in less than a year?

Mohamed El-Erian, president of Queen’s College, Cambridge, warns of the dangers of a sudden reversal of US interest rate policy. This is a trap that many central banks fell into in the 1970s and 1980s with the so-called “stop” policy.

Markets are worried about a recession. Now that central banks have raised interest rates, the risks of economic deflation are increasing. This does not change the fact that critics are convinced that the Federal Reserve may have intervened too late to cool inflation. But what do we have to say about the European Central Bank? It will only raise interest rates in July for the first time in eleven years.

The Fed threatens to make another mistake

According to El-Erian, the Fed has already made several policy mistakes. First, the Fed continued to classify inflation as “transient” through the end of November, allowing the forces driving inflation to expand and stabilize further. Second, after being late to correct that characterization, it failed to act in a timely and decisive manner — so much so that in March, when the US recorded inflation above 7 percent, it was still pumping massive amounts of money into the economy. It was,” he says in an interview with financial times†

Now a third gaffe threatens: “Markets believe that a central bank trying to catch up with a recession risks pushing the US economy into a recession.”

Markets are now also concerned about volatile monetary policy, “with the Federal Reserve aggressively raising interest rates to have to turn around by the end of the year due to the risk of a recession”.

“stop go”

It’s not just about the Fed’s reputation, which has already been hit hard. It is also about the economic reality of the poorest families, which have to lose out the most in purchasing power. It is no coincidence that the three sectors most affected by inflation are also those on which poor households spend the most: energy, food and real estate (rent).

But what is more worrying is the money policy as the Federal Reserve is constantly raising and lowering interest rates because it does not know how to react to the economic situation. “In this scenario, the Fed is without credibility and strong expectations in the classic style.”stop go“They are trapped, just like many Western central banks in the 1970s and 1980s,” warns El-Erian.

Such policies are often associated with the “political business cycle,” in which politicians try to stimulate the economy before elections and fight post-election inflation. This was the case, for example, in the United Kingdom in the 1970s and 1980s. The British government then faced very high inflation fueled by energy prices. This is similar to the situation today.

Instead, it is best to follow a reliable, consistent, and ultimately reliable path. Good central bank policy requires the Fed to lead the markets rather than follow them, and for good reason. An informed Federal Reserve with a reliable view of the future reduces the risks of devastating spillovers to financial markets (…) and improves the performance of the real economy.”

(ns, lb)