Riskier than meets the eye.

The Fed's Risky Bet on Growth

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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The U.S. Federal Reserve is trying to squeeze a bit more out of a stimulus policy that relies heavily on artificially boosting stock and bond markets to generate growth. In doing so, it is running a higher risk of financial instability, and increasing its dependence on a Congress that shows little sign of being able to handle fully its economic responsibilities.

On Wednesday, the Fed confirmed that it will end its exceptional bond-buying program next month, but stopped short of changing the language in its policy statement to signal an end to near-zero interest rates -- the widely expected next step in exiting what has been an unexpectedly long period of experimental monetary stimulus. By maintaining its support for the economy, the Fed hopes to create momentum that will more than offset the greater threat of financial instability.

The trade-off will work well for Main Street, as opposed to just Wall Street and the wealthy, only if the government and companies take the growth baton from the Fed -- for example, by investing in infrastructure and expansion. Otherwise, there's an unsettling chance that the U.S. will end up stuck in the economic doldrums, and the Fed's regulatory tools will prove insufficient to counter future financial malaise.

Wednesday's policy decision was always going to be a tough call. Recent economic data would have supported both the end of bond-buying and a change in the Fed's interest-rate language. But the U.S.'s excessive dependence on loose monetary policy, together with the unsettled global economic and geopolitical environment, tilted the balance of risks to the downside.

The Dow Jones Industrial Average immediately hit a new record high, illustrating the financial risk-taking that the Fed's policy will inevitably encourage. To minimize the possible damage, the economy needs to pivot from Fed-induced to genuine growth drivers, and do so before more of the disruptions inflicted by the recession become permanent.

Given the intensifying political posturing ahead of November's congressional elections, it is hard to see lawmakers coming together to agree on the economic measures that the country needs. The private sector is growing more confident, but it still lacks the momentum to get the economy to escape velocity. If this doesn't change, the Fed's policy bet could end in disappointment.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mohamed Aly El-Erian at melerian@bloomberg.net

To contact the editor on this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net