The Fed in a bind

The Pak Banker - - OPINION - Mo­hamed A. El-Erian

PITY the Fed­eral Re­serve. As it demon­strated again Wed­nes­day, the cen­tral bank re­mains hostage to chang­ing fi­nan­cial mar­kets and global eco­nomic con­di­tions. This is mak­ing it very hard for Fed of­fi­cials to com­mu­ni­cate a clear and con­sis­tent pol­icy path that will be pur­sued for any sig­nif­i­cant pe­riod of time. The Fed's state­ment rec­og­nized a slow­ing of U.S. eco­nomic growth that en­com­passes in­ven­tory spend­ing and ex­ports. It also seemed less con­fi­dent about the out­look for in­fla­tion ris­ing to the tar­get level. Fur­ther­more, as an ac­knowl­edg­ment that this un­wel­come do­mes­tic slow­down is prin­ci­pally driven by eco­nomic de­vel­op­ments abroad and volatile global fi­nan­cial mar­kets, Fed of­fi­cials shied away from set­ting out their tra­di­tional as­sess­ments of the "bal­ance of risks."

The cen­tral bank con­firmed what mar­kets had an­tic­i­pated and priced into the short-term seg­ments of the fixed-in­come mar­kets: Not only would there be no im­me­di­ate re­peat of the De­cem­ber in­ter­est rate hike, but it will be dif­fi­cult for the Fed to make good on the ex­pec­ta­tions of four hikes that it sig­naled for 2016. As a re­sult, of­fi­cials are be­ing forced to re­vise -- yet again -- their com­mu­ni­ca­tions; and there will be much com­plain­ing about their pol­icy con­vic­tion and cred­i­bil­ity. All of this re­flects a much deeper and un­for­tu­nate sit­u­a­tion. The U.S. econ­omy has re­peat­edly failed to achieve the eco­nomic liftoff that it is ca­pa­ble of and needs, and that has made the Fed overly vul­ner­a­ble to de­vel­op­ments abroad and volatile global fi­nan­cial mar­kets. The cen­tral bank has be­come hostage to in­ad­e­quate pol­icy re­sponses around the world, but also to an ex­ces­sively par­tial U.S. ap­proach that has been too re­liant on ex­per­i­men­tal mon­e­tary pol­icy for too long. As I ex­plain in depth in my new book, "The Only Game in Town: Cen­tral Banks, In­sta­bil­ity and Avoid­ing the Next Col­lapse," it is up to other pol­icy mak­ers, such as a func­tion­ing Congress work­ing co­op­er­a­tively with the ex­ec­u­tive branch, to ex­tri­cate the Fed from an in­creas­ingly dif­fi­cult sit­u­a­tion. The longer they wait, the greater the threat of the Fed re­peat­edly be­ing un­able to set out and main­tain a con­sis­tent pol­icy stance. And the more it is un­able to do so, the greater the risk that the Fed will go from be­ing part of the so­lu­tion to be­com­ing part of the prob­lem.

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