OPINION: The Fed’s ongoing inflation mistake is an error that will likely be remembered as one of its biggest ever, Mohamed A. El-Erian writes.
CAMBRIDGE, England —A close friend who has been incredibly successful in his tech career once observed that an initial suboptimal decision is likely to lead to a series of subsequent bad decisions. Economists call this “multiple equilibria.” And the Federal Reserve, the world’s most influential monetary institution, finds itself in the midst of such a situation regarding inflation—with implications that extend well beyond U.S. economics and finance.
It was not until the end of November 2021 that Fed Chair Jerome Powell—finally and belatedly—declared it was time to “retire” the word “transitory.” But then came the second stage of the Fed’s multifaceted blunder. The policy adjustments that followed Powell’s statement were extremely modest, with the Fed announcing only that its large-scale asset-purchase program, known as quantitative easing , would be wound down entirely by March 2022.
Nothing highlighted better the big hole that the Fed had dug itself than the fact that, as late as February 2022, it was continuing its QE liquidity injections, even though inflation was running at 7.5%, a 40-year high. Astoundingly, and despite calls to act, the Fed had rejected an immediate halt to QE at both its December and January policy meetings.
You can’t get there from here The Fed’s suboptimal decisions over the past 12 months mean that its next policy decision also is likely to be suboptimal. Even if it had a good feel for the current “first best” policy response, the Fed is unlikely to be able to implement it, given how far policy makers have fallen behind economic realities. To paraphrase the old Irish joke, you can’t get to a first-best policy starting from here.
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