Still muddling through.

Fed's Lack of Conviction Is Warranted

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 Federal Reserve delivered today what I and many others expected, in both actions and words. Rather than sending a well-telegraphed signal for going forward, it is keeping its options open in an unusually fluid economic, political and global environment.

As anticipated, the Fed completed its exit from the large-scale purchases of securities (or QE3). In ending this extraordinary phase, the Fed understandably sidestepped any comprehensive assessment of, to use former Chairman Ben Bernanke's famous phrase, the "benefits, costs and risks" of its highly experimental policy tool. Instead, it just noted the "substantial improvement in the outlook for the labor market" since the inception of the policy.

Also, as expected, the Fed reaffirmed its position on maintaining low interest rates for a "considerable time." In doing so, it delivered a rather open-ended assessment of recent economic developments and, therefore, of its possible policy course down the road.

Fed officials welcomed the continued improvement in the economy, particularly signs that the underutilization of labor resources is gradually "diminishing," though only "gradually" despite "solid gains and a lower unemployment rate." On the second element of its dual mandate -- stable inflation -- the central bankers acknowledged the fall in market measures of forward inflation but played down the risk of damaging deflation by also pointing to other metrics of inflationary expectations.

This apparent lack of conviction, while frustrating to many, is understandable and warranted.

Because it faces a historically unusual mix of cyclical, structural and longer-term issues, the behavior of the U.S. economy isn't easy to capture well with existing models, including those used by the central bank. The nation's policy response has fallen well short of the "first best" given the constraints imposed by the political polarization in Congress on virtually every policy-making entity other that the Federal Reserve; and the central bank doesn't have sufficient instruments to compensate for this.

Finally, the global economy is far from accommodating, given the challenges facing Europe, Japan and a number of emerging economies (in some cases accentuated by geopolitical tensions).

In short, the Fed ended up taking the approach that was suggested in last week's column -- that is, to muddle through a complicated situation, including minimizing the risks of a short-term policy mistake and of a market accident. The longer-term issues, including the consequential ones, were left for another time.

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:
Katy Roberts at kroberts29@bloomberg.net