Quantitative Easing

US Fed Should Go Beyond Simply Doubling Its QE Cut Rate

After the hot US inflation figures last week, it would be unwise and unfortunate for the US Federal Reserve to resist at its policy meeting this week what has become widespread calls for it to double the rate at which it gradually decreases. his monthly bond purchases. In fact, the Fed should go much further.

Sadly, November’s rather shocking Consumer Price Index report was no exception. He reaffirmed other data indicating a stronger and more persistent inflation process than the Fed believed.

Annual inflation fell from 6.2% to 6.8%, a level not seen since 1982 during the mid-Paul Volcker era at the central bank. The basic measure of inflation, which is supposed to exclude the most volatile components historically, even if their impact on the most vulnerable segments of the population is particularly negative, has fallen from 4.6% to 4.9%, also the highest for several decades.

Having failed to foresee this year’s spike in inflation and repeatedly resisted to adjust their thinking enough on the basis of up-to-date and compelling information, the few inflation apologists remaining on Friday still seem inclined to hang on. to the idea of ​​”transient” engines to minimize an already damaging situation. In doing so, they fail to recall the increasing likelihood of two phenomena that are uncomfortably familiar to those who have experienced or studied past episodes of high inflation:

First, the question is not whether some of the most powerful drivers of inflation will lose power; they certainly will. The question is whether this happens after they plant the seeds for a broader inflation dynamic, which they are already doing.

Second, the question is not whether this broader inflation dynamic will eventually reverse; it will be. Rather, it is about limiting the damage that occurs during and after such a turnaround.

Historically, as the most powerful central bank in the world, the Fed has been at the center of these two issues, with significant domestic and international effects. By failing to demonstrate a credible understanding of inflation and acting accordingly in a timely manner, the Fed may itself be the cause of unanchored inflation expectations. This creates a much more powerful and problematic dynamic than the original catalyst for inflation, which in this case is a sudden shortfall in aggregate supply due to supply chain disruptions and labor shortages. -work. As inflation rises higher and more sustainably than it otherwise would have been, the danger increases not only of an unnecessary economic downturn, but also of an outright recession. Historically, this has been the result of the Fed having to curb policy in a belated and haphazard attempt to regain control of its inflation credibility and mandate.

All of this undermines livelihoods in two unnecessary ways, both of which hit the poor particularly hard: first, by eroding purchasing power, especially for those less able to afford it, and second, by causing unemployment. .

The US Fed is already seriously behind on developments on the ground and the associated political imperatives. He should have, as I have been saying for months now, acted much sooner to release the accelerator “from the pedal to the metal” by limiting bond buying in late spring and early summer. Instead, he simply repeated the mantra that inflation was transient and in doing so undermined actions taken by Joe Biden’s administration to curb inflation.

Fortunately, the US central bank still has a window, albeit small and rapidly narrowing, to act in an orderly manner that minimizes undue damage to livelihoods. That would force him to move beyond the current political call for consensus in three ways this week:

Be honest and transparent about why he was so wrong in his assessment of inflation (which I called one of the worst Fed inflation forecasts of all time a few months ago. time, and which risks a serious policy error).

Go beyond doubling the amount by which it cuts monthly asset purchases.

Rather than a simple statement insisting that a cut in bond purchases doesn’t signal anything about future rate hikes, recognize the possibility that it will need to hike rates soon after quantitative easing ends. .

The Fed has a simple choice this week. It can either continue its mismanagement of inflation or start to regain its credibility and control over inflation and monetary policy rhetoric.

If the US Fed opts for the former, its institutional position will be even more affected, making the effectiveness of its policy more elusive in the future; the livelihoods of many people will suffer unduly; The already disturbing trio of inequalities of income, wealth and opportunity will deepen and its internal divisions will widen.

Mohamed A. El-Erian is President of Queens’ College, University of Cambridge and is a part-time Chief Economic Advisor at Allianz

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