Stock markets responded nervously to Wednesday's indications that America’s central bankers are getting more worried about the collateral damage of quantitative easing. But the implication is not that the US Federal Reserve will look to end its unconventional policy approach any time soon. Rather, it is that problems multiply when other policy makers and politicians fail to contribute to a balanced and comprehensive policy approach.
According to the minutes of its January meeting, the Federal Open Market Committee discussed – to use Fed chairman Ben Bernanke’s elegant formulation from August 2010 – the possibility that the expected "benefits” of QE could be offset by mounting "cost and risks”.
As I have argued in the Financial Times, including last week, this is part of a broader set of challenges facing most western central bankers – and an increasing number in emerging economies. As a result of varying degrees of political dysfunction, monetary institutions have been thrust into leadership roles for which they find themselves ill-equipped. As such, they are pursuing too many objectives using tools that are too few, too indirect and too imperfect.
The longer this persists, the greater the scope and scale of QE’s "costs and risks”. In the process, the Fed’s credibility and political autonomy will be questioned.
Because of this, some are interpreting the latest Fed minutes as signalling that the FOMC may seek an early end to QE. While possible, this is not probable for two reasons.
First, market reactions are unlikely to force the Fed to abandon QE. Unlike in other open economies, the US central bank does not alter policy course because of exchange rate movements. And while inflationary expectations may well increase over time, they are unlikely to do so at a highly alarming rate. This is especially so when an orderly rise in inflation, along with the Fed’s current regime of "financial repression” (where artificially low interest rates subsidise debtors at the cost of creditors), serve to gradually deleverage overextended segments of the economy.
Second, unlike the Bank of Japan, which is now succumbing to the political pressure applied by Prime Minister Shinzo Abe, America’s highly polarised politicians are in no position to force change on the Fed. Not only are they too busy with self-inflicted fiscal problems; I suspect they are also relieved that the Fed attracts so much of the economic policy focus.
The only way the Fed will abandon QE any time soon is if America’s growth rate and job creation reach "escape velocity”. For this to happen, Congress would need to encourage tailwinds rather than headwinds. Absent that, it will take some time for the economy’s ongoing endogenous healing to attain critical mass.
Since Congress doesn’t look to be getting its act together any time soon, the Fed will face an uncomfortable choice at every policy meeting in the next few months: either continue to use imperfect policy tools and risk greater collateral damage on a widening front; or stop and undermine the economy’s momentum.
Today’s world of dysfunctional politics is one that pushes central banks further away from their comfort zone and excludes the best possible responses. The resulting inconsistencies can only be resolved through a more comprehensive policy approach that deals directly with the west’s challenges of too little growth, too much debt and too polarised a political discourse. In the meantime, central banks will have no choice but to opt for what they perceive as the lesser of two evils – that of maintaining a visibly imperfect policy stance.
Mohamed El-Erian is the chief executive and co-chief investment officer of Pimco
Copyright the Financial Times 2013.