down to its often-repeated target three years after annual consumer price rises topped 9 %, the Fed faces the risk of protracted inflation that would quickly undermine its efforts to counter the potential rise in unemployment. Moreover, lessons from central banking history suggest that when faced with both parts of the dual mandate going against it, the Fed should give priority to putting the inflation genie back in the bottle.
This is a particularly relevant consideration in the current situation where the sensitivity of unemployment to interest rates pales in comparison to the uncertainties companies and households
Lessons from central banking history suggest that when faced with both parts of the dual mandate going against it, the Fed should give priority to putting the inflation genie back in the bottle.
Powell eagerly dismissed the information content of the weakening soft data and reintroduced the concept of“ transitory” when opining on the inflationary effects of the tariffs. Fortunately, he walked back both statements rather than wait for many months as he did in 2021.
Now the Fed needs to judge whether it should respond to the prospects of higher unemployment by cutting interest rates aggressively, or to hotter inflation by staying put or even opening the door to considering the possibility of a rate hike. For their part, market participants have rushed to price in more than four reductions this year, with some even calling for an emergency intermeeting cut.
The reaction of traders and investors should not come as a surprise. It reflects how they have been trained repeatedly by the Fed to expect looser financial conditions the minute there are any signs of unusual market volatility or economic weakness. And, judging from its history, it is probably what this Fed will be tempted to do.
Yet the expected rise in inflation makes such a policy response far from straightforward. Indeed, it could even be dangerous.
Having failed to bring inflation back feel due to the manner tariff policy has been designed, communicated and implemented. Indeed, to quote the guidance provided on Bloomberg Television by Eric Rosengren, the former president of the Boston Fed, the issue of rate cuts should be approached“ slowly, gradually and reluctantly.”
What the Fed needs more than ever is a good dose of humility, something that it has lacked in recent years to its and the economy’ s detriment. Such humility would help reduce the risk of another bout of slippages in analysis, forecasts, communication and policy design. It would also help counter the threat of a prolonged and damaging period of stagflation.
MOHAMED A. EL-ERIAN is a Bloomberg Opinion columnist. A former chief executive officer of Pimco, he is president of Queens’ College, Cambridge; chief economic advisor at Allianz SE; and chair of Gramercy Funds Management. He is author of The Only Game in Town. This article was provided by Bloomberg News.
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