Tags: El-Erian | Fed | Collateral | Damage

Pimco’s El-Erian: More Fed Action May Cause ‘Collateral Damage’ to US

Wednesday, 18 Jul 2012 09:25 AM

The U.S. economy will continue to soften and the Federal Reserve will intervene with stimulus tools to stave off decline, but such moves could result in “collateral damage” to the economy, said Mohamed El-Erian, CEO of Pimco, manager of the world's largest bond fund.

To spur recovery so far, the Fed has slashed benchmark lending rates to near zero percent, bought bonds from banks that pump the economy full of liquidity and further keep borrowing costs low — a powerful tool known as quantitative easing (QE) — and reshuffled its Treasury holdings by stocking up on longer-dated securities and selling shorter ones to further push rates down, a tool known as Operation Twist.

Expect the Fed to step in again, likely with another round of QE, although collateral damage could ensue.

Editor's Note: You Owe It to Yourself to Know What Obama and Bernanke Are Hiding From Americans

Congressional unwillingness to correct fiscal imbalances could hamper growth, and considering that QE tends to apply inflationary pressures down the road and produces diminishing returns with each use, the result could be more painful if lawmakers hold back growth due to a political inability to adjust tax and spending policies.

"Having exhausted long ago the effectiveness of traditional monetary policy tools, the Fed has no choice but to consider another mix of unconventional measures – specifically, additional purchases of securities, a lower interest rate on excess reserves, an even more aggressive communication policy, and enhanced access to the discount window," El-Erian wrote in a Financial Times OpEd.

"But, more of the same will not have a durable beneficial impact, especially if other policymakers remain missing in action," El-Erian added.

"Indeed, the advantages of another round of unusual Fed activism are declining while the risk of both collateral damage and unintended consequences is material and growing."

Fed stimulus measures aim to lower interest rates to expand the economy, though its tools can do little to tackle fiscal problems, which will come to a blow at the end of the year, when tax breaks are scheduled to expire while automatic spending cuts kick in, a combination known as a fiscal cliff.

Bernanke told lawmakers at a recent testimony they must act to adjust the timing and scope of expiring tax cuts and inbound spending cuts to prevent the economy from cooling further.

"The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery,” Bernanke said in his testimony to the Senate banking committee, according to a copy of his speech.

“Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.”

Editor's Note: You Owe It to Yourself to Know What Obama and Bernanke Are Hiding From Americans



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2012-25-18
Wednesday, 18 Jul 2012 09:25 AM
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