Fed's Conflict Is a Symptom of Problems It Can't Solve Alone
(Bloomberg Opinion) -- When they conclude their two-day October policy meeting on Wednesday, Federal Reserve officials will find it much easier to communicate what they did than why they did it. Murkier still is what lies ahead.
Conflicting and, at times, confusing factors fuel growing worries about the effectiveness of monetary policy in much of the advanced world. Even the Fed, the world’s most powerful monetary institution, struggles to strike a delicate policy balance. Based on the experiences of the European Central Bank and the Bank of Japan, if the Fed hopes to please all constituencies, that will prove elusive in the short term and potentially harmful over the longer term.
The Fed is almost certain to cut interest rates by 25 basis points, the third reduction this year. It will do so despite positive developments in six areas that Fed officials have repeatedly cited as reasons for concern and for prior policy stimulus:
- a relative improvement in the outlook for the domestic economy, attributable in part to a de-escalation of trade tensions between China and the U.S.
- record levels for U.S. equity indexes
- a steepening of the U.S. Treasury yield curve in the context of higher market yields and less talk of a U.S. recession
- a weaker dollar
- a rebound in housing (one of the most sensitive sectors to Fed policy)
- lower likelihood of a disorderly Brexit
Instead, the Fed will justify the rate cut by citing continuing concerns about the fragile international economic environment and the lack of definitive resolution to policy uncertainties. It is less likely to acknowledge another factor that I believe may also be driving the policy decision, and especially so after the sobering experience of the market disruptions of the fourth quarter of 2018 – that is, its hesitation to disappoint markets that, today, have already priced in not only an October cut, but also one to two more in the next year or so.
That combination is also why Jerome Powell, the Fed chairman, will try to deliver a very nuanced message at the press conference that follows the release of the Federal Open Market Committee’s policy decision.
While refraining from a clear and explicit commitment to further rate cuts, he is likely to go out of his way to reassure markets that the Fed stands ready to act should economic or policy prospects deteriorate. He will also seek to deflect attention from the unusually prolonged efforts to decisively stabilize the wholesale bank funding market.
His hope in all this is to keep his policy options open in what is an unusually uncertain economic, financial and policy environment. The risk in this approach is that he could come across as hostage to a “muddled middle” that lacks strategic anchoring and effectiveness. Attempting to strike a balance is also likely to expose the Fed to continued criticism from many sides, including those who feel that the Fed should be doing more to support the economy and, on the other side, those who worry that additional policy stimulus will only increase the risk of future financial instability.
To be more decisive, strategic and successful, the central bank’s policy actions need to be part of a much more comprehensive package that ends uncertainties about the global trade regime, implements additional pro-growth measures (including a well-targeted program to rehabilitate and modernize productivity-enhancing infrastructure), and improves global policy coordination. This requires the cooperation of several government entities, both in the U.S. and abroad, most of which remain stymied by political issues.
The problem is even worse elsewhere in the advanced world, especially for the European Central Bank, whose president, Mario Draghi, will be succeeded this week by Christine Lagarde.
Having been pushed ever deeper into unconventional policies, including negative interest rates and quantitative easing that is increasingly being referred to as “QE infinity,” the ECB finds it increasingly difficult to do more, rightly fearing that the costs and risks of further policy stimulus could well outweigh the benefits. At the same time, it feels unable to unwind its distortionary policy interventions, worried that this would disrupt economic activity. Its current compromise position doesn’t help either, amplifying loud internal divisions and undermining its external credibility.
Central bank policy announcements continue to attract a lot of attention even though too many years of them being the “only game in town” policy-wise have materially reduced their ability to change the economy for the better. This week’s FOMC meeting will be no exception, highlighting deepening dilemmas and even greater dependence on other government entities which, unfortunately, have yet to step up to their policy responsibilities.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."
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