PIMCO CEO Mohamed El-Erian says that the Federal Reserve’s decision to extend Operation Twist through the end of this year illustrates the degree to which the U.S. is falling further behind its first best policy responses.
“… in continuing to act on its own, all the Fed will do is buy some time that will again be wasted by the country’s politicians," El-Erian writes in the Financial Times.
“Meanwhile, collateral damage will mount, making the next policy steps even more excruciating.”
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Not so long ago, the Fed was discussing how to exit the unconventional policy phase initiated in the midst of the 2008 global financial crisis, El-Erian notes.
Instead—having already ballooned its balance sheet to 20 per cent of U.S. gross domestic product—it will now exchange even more of its short-term Treasury holdings (up to 3-year maturities) for longer-dated (6-30 year) bonds.
“This extension of ‘operation twist’ has, as an intermediate objective, repressing market interest rates to push investors to assume more risk, trigger the wealth effect and reignite animal spirits," says El-Erian. “While the Fed has been able to normalize market functioning and boost valuations, it has repeatedly failed to deliver on its desired economic outcomes.”
He says such Fed activism alters the functioning of markets, contaminates price discovery and distorts capital allocation.
“Unfortunately, there is little to suggest that things will be any different this time around.… While the Fed should be commended for trying to deliver a second best, net benefits will prove even more difficult to secure."
"In the process, look for greater distortions that will take years to resolve."
Bloomberg Business Week reports that Fed Chairman Ben Bernanke is signaling that the Fed will probably add to its record stimulus should the economy fail to make sufficient progress in creating jobs for 12.7 million unemployed Americans.
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