Tags: Pimco | El-Erian | Fed | Purgatory

Pimco’s El-Erian: Fed Stuck in ‘Policy Purgatory’ but Will Act Soon

Thursday, 02 August 2012 01:36 PM

The Federal Reserve has been one of the most activist central banks since the 2008 meltdown, jolting the U.S. economy with an arsenal of traditional and unorthodox monetary policy tools.

Lately, however, the U.S. central bank has stuck to a wait-and-see approach, but that’s just temporary, so expect more stimulus soon, says Mohamed El-Erian, CEO and co-chief investment officer of Pimco.

Some say the Fed is merely giving Congress time to do its part to spur recovery by making fiscal reform.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

But that’s not going to happen in an election year, El-Erian says, so expect the Fed to jolt the economy with stimulus measures soon.

“The Fed’s attempt to overcome its policy dilemma has little chance of succeeding given the degree of political dysfunction in Washington. It is only a matter of weeks until, once again, Fed officials will feel compelled to act, and despite full knowledge that their measures will have limited effectiveness in delivering desired outcomes,” El-Erian writes in a Financial Times commentary.

“Most fundamentally, what is being illustrated again in all this is that what the U.S. faces today is as much a political problem as it is an economic one. Until the political system steps up to its strategic leadership challenge, America will risk the trap of policy purgatory,” he notes.

Since the downturn, the Fed has rolled out two rounds of bond buybacks known as quantitative easing (QE), snapping up $2.3 trillion in Treasurys and mortgage securities held by banks to spur recovery by flooding the economy with liquidity.

The U.S. central bank has also rolled out a $400 billion program that shuffles its Treasury holdings, known as Operation Twist, later expanding it by another $267 billion.

Under Operation Twist, the Fed purchases longer-duration Treasury securities in the market while selling an equal amount of shorter-duration Treasury securities with the aim of keeping long-term interest rates low.

The Fed said in its recent monetary policy statement that it would stand by and jolt the economy anew should the economy soften.

Fiscal matters are threatening the economy more, however.

At the end of the year, the Bush-era tax cuts expire and automatic cuts to government spending kick in, a combination known as a fiscal cliff that could send the country sliding right back into recession if left unchecked by Congress.

“So, this time around, the Fed decided to talk the talk but not walk the walk. It is unwilling to do anything now, also reflecting a desire to keep dry whatever policy ammunition remains in the event that Washington is unable to deal with the fiscal cliff and Europe takes another turn for the worse,” El-Erian writes.

“And while it signaled a willingness to do more should conditions deteriorate, I suspect that it wishes this to be in support of other policy measures rather than substituting for them,” he continues.

Lawmakers have hinted that after elections, they might address the fiscal cliff and quickly adjust the timing of tax hikes and spending cuts, even after it passes on Jan. 1, 2013, by dealing with it on a retroactive basis.

Still, even if the Fed does intervene later this year, the problem with Fed tools, experts say, is they carry diminishing returns, packing less and less of a punch each time the Fed rolls them out.

“They’ve done QE1, QE2, Twist 1 and Twist 2, so that’s four actions of unconventional monetary policy. One of them worked: QE1,” Stephen Roach, former chairman of Morgan Stanley Asia and current Yale economist, told CNBC.

“The others have not worked. The Fed puts out research that says they all worked but that’s propaganda. They’re batting .250, and if you were a baseball player batting .250 you’d get sent down to the Minor Leagues.”

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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Thursday, 02 August 2012 01:36 PM
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