This week offered another illustration of a dual policy dynamic in the U.S. that has been undermining both short- and longer-term economic prospects for the past few months: too limited a response for necessary fiscal measures and pro-growth structural reforms and too much reliance on monetary policy tools that are close to, if not already past, the point of limited effectiveness.
Although some rebalancing of this policy mix is likely next week, it unfortunately will not be enough to significantly alter longer-term economic prospects. It will also underscore the need for a bold policy response on the part of the incoming Biden administration.
Congressional lawmakers will spend the next few days finalizing, after protracted discussions, a fiscal relief package in response to the significant Covid-related pain and suffering felt by a growing number of Americans. This comes on the heels of data pointing both to a continuing contraction in retail sales and a reversal in the labor market, with initial jobless claims heading back up and likely to exceed 1 million in the next few weeks.
The outcome of the congressional negotiations will most likely satisfy two immediate priorities: maintaining funding for current government operations and providing new financial assistance to those most in need. Likely to be missing will be other short-term relief measures, including assistance to local and state governments and measures aimed at addressing the danger of declining productivity and higher household economic insecurity even after the distribution of Covid-19 vaccines.
The immediate injection of fiscal relief should help moderate what recent data suggest is an accelerating loss of momentum for the economic recovery. But it will not alter significantly the general direction of the bumpy road in the short term. Nor will it do much to offset the longer-term risks to economic, social and institutional well-being.
This recognition is behind the Federal Reserve’s decision this week to extend its large-scale asset purchase program. Indeed, the additional policy activism is not in response to any financial market malfunction or a tightening of financial conditions. Instead, it is a desire to provide a stronger bridge to a future when vaccine adoption opens the way for a return to greater economic and social normalcy.
All indicators I look at suggest that financial markets are functioning just fine and that overall financial conditions are extremely loose in capital markets — if not too loose in the sense of enabling and encouraging excessive and potentially irresponsible risk-taking. Instead, it is the risks associated with a weakening of economic indicators that has led the Fed to follow the European Central Bank deeper into what I have called a policy paradigm of “conscious active inertia”: Doing more of the same even though it is unlikely to have a material impact on the economy.
This basic policy imbalance is one that, arguably, has been around since 2010 and has become so much worse in the last few years, particular in 2020. It is the main driver of the “great disconnect” between Main Street and Wall Street and increases the risks to growth, financial stability and institutional soundness over the longer term. Simply put, the central banks are repeatedly trying to borrow growth and financial stability from the future to limit damage now; and they are doing so also at a risk to their own credibility and effectiveness.
The narrow fiscal package that is likely to emerge in the next few days from this lame duck congressional session will force President-elect Joe Biden’s administration to deal immediately with a long-delayed priority: supporting state and local governments. The challenge will be to pursue this while simultaneously dealing with other demands: First, making progress on the additional policy priorities I have discussed in earlier columns that deal with both short- and longer-term economic recovery and, second, supplementing this with focused measures to counter the significant deterioration in an inequality trifecta (income, wealth and opportunity) that erodes both economic dynamism and social integrity.
The protracted unbalanced policy mix has naturally led the vast majority of Americans, including me, to welcome a narrow fiscal agreement as much better than no agreement. The collective challenge is to ensure that whatever comes out in the next few days is a means to a more comprehensive fiscal and structural reform package that limits longer-term economic scarring and allows for an orderly reduction in what has been a far too excessive and prolonged policy reliance on the Fed.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is president of Queens’ College, Cambridge; chief economic adviser at Allianz SE, the parent company of Pimco where he served as CEO and co-CIO; and chair of Gramercy Fund Management. His books include 'The Only Game in Town' and 'When Markets Collide.'
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