Tags: Pimco | El-Erian | fed | Response

Pimco's El-Erian: Fed Needs to Find Appropriate Policy Response

Tuesday, 09 Aug 2011 12:25 PM

The Federal Reserve needs to act in a way that points the country in the right direction and avoid propping up the economy for a while only to have it slip back into uncertainty again, says Mohamed El-Erian, CEO of Pimco, the world's largest bond fund.

Central Banks can carry out policies to steer economies through turbulent waters, but it needs to do so by blowing lasting winds in its sails and not revving the throttle on the engine in spurts and letting it stall.

Rolling out policies such as quantitative easing, a $600 billion bond buyback program that served as a shot of liquidity into the economy's arm and known widely as QE2, won't work without more coordinated efforts with the central government and other entities.

That's true in the U.S. and it's true with the European Central Bank.

"Remember the Fed and the ECB are just a bridge. The problem with QE2 was that it was a bridge to nowhere. And that's why we have given up all the gains of QE2. Ultimately at the end of that bridge has to be Washington, D.C., with more coherent economic policies," El-Erian tells CNBC.

"We need structural solutions for structural problems. We have a medium-term public-finance issue. We have a housing market that is not functioning properly, we have a banking system that's lending in a very uneven fashion and we have a labor market that's not functioning properly. Unless you get a simultaneous and coordinated reaction to all four, we are going to be talking about this, unfortunately, for months and months to come."

The Federal Reserve will play a crucial role in keeping the economy from dipping back into recession.

QE2, for example, may have not created growth or lowered unemployment rates but it did steer the economy away from deflation.

Growth, however, is needed.

"Because of the state of the housing market, because of the state of labor markets, we need as an economy to grow over 2 percent. If we don't, then we hit stall speed," El-Erian says, referring to aircraft terminology that if a plane flies to slowly, it cannot generate enough lift to sustain flight and therefore crashes.

Markets may be tanking in wake of the Standard and Poor's decision to downgrade the U.S., but they are functioning normally, unlike in 2008, when credit markets froze and fears erupted to the point that people were worried over the structural health of the U.S. financial system.

Still, the Fed has less arrows in its quiver to fight off recessionary pressures.

But it needs to act in a way that doesn't prop up the economy today only to have it tank a new down the road.

"It's critical the Fed acts as a bridge to somewhere and not a bridge on its own."

On the other side of the bridge lies the White House, where President Barack Obama admits that political wrangling over debt issues is hindering recovery.

"It's not a lack of plans or policies that's the problem here," says Obama, citing proposals put forth by the Senate's Gang of Six and an agreement he had previously reached with House Speaker John Boehner on cutting deficits and adjusting government borrowing limits, according to Bloomberg.

"It's a lack of political will in Washington. It's the insistence on drawing lines in the sand, a refusal to put what's best for the country ahead of self-interest or party or ideology. And that's what we need to change."

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The Federal Reserve needs to act in a way that points the country in the right direction and avoid propping up the economy for a while only to have it slip back into uncertainty again, says Mohamed El-Erian, CEO of Pimco, the world's largest bond fund. Central Banks can...
Pimco,El-Erian,fed,Response
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2011-25-09
Tuesday, 09 Aug 2011 12:25 PM
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