The Federal Reserve’s year-long aggressive monetary tightening efforts could turn out to be one of the most significant policy errors in the last several decades, according to renowned economist Mohamed El-Erian.
El-Erian shared excerpts from the Peterson Institute for International Economics (PIIE) and the Financial Times that reinforced his view that the U.S. central bank is committing egregious policy missteps.
“As first mentioned almost a year ago, I fear that this may well end up being the biggest Fed policy mistake in several decades,” the chief economic adviser at Allianz tweeted on Monday.
The PIIE lamented on the Fed’s macroeconomic scenarios to determine the 2023 stress tests on large banks. The think tank noted that the measurements were not diverse enough and failed to address the potential effects of higher interest rates on financial institutions.
Silicon Valley Bank was not subjected to routine stress tests. However, experts aver that the California-based bank would have passed because it had been considered “well-capitalized” by the Fed. The tests also gauged how the company would have handled a falling GDP, rising unemployment, and tighter credit conditions. Today’s primary economic challenges are rampant price inflation and higher interest rates.
The Financial Times article contained comments from Julius Baer CEO Philipp Rickenbacher that acknowledged the possibility of “some room for policy mistakes at the highest levels when it comes to interest rates.”
‘One Mistake After Another’
El-Erian has been highly critical of the Federal Reserve for the past year.
He penned an op-ed on MarketWatch on Monday, asserting that the institution “has slipped in its analysis, forecasts, policymaking and communication” and has made “one mistake after another.”
“The Fed’s problems should worry everyone. A loss of credibility directly affects its ability to maintain financial stability and guide markets in a manner consistent with its dual mandate of maintaining price stability and supporting maximum employment,” he wrote.
In the end, Fed Chair Jerome Powell will be remembered as Paul Volcker or Arthur Burns, El-Erian purported. The former had conquered skyrocketing inflation in the 1980s. The latter kept monetary policy too loose for too long, resulting in stagflation (a blend of slow economic growth and rampant inflation).
Federal Reserve Chair Jerome Powell as he testifies before the House Committee on Financial Services on Capitol Hill in Washington on March 8, 2023. (Anna Moneymaker/Getty Images)
In October, he told CBS’ “Face the Nation” that the central bank made two crucial errors: mischaracterizing inflation as transitory and failing to respond to high inflation “in a meaningful way.”
“So yes, unfortunately, this will go down in a big policy error by the Federal Reserve,” he said.
“Even Chair Powell has gone from looking for a soft landing to soft-ish landing to now talking about pain. And that is the problem. That is the cost of a Federal Reserve being late. Not only does it have to overcome inflation, but it has to restore its credibility.”
Last month, El-Erian asserted that the Fed is facing a “trilemma”: inflation, financial stability, and economic growth.
He suggested that the Fed should hit the pause button on its tightening campaign, adding that he is concerned about how the banking turmoil could result in credit challenges throughout the national economy.
“I’m more worried about the credit issues — and that really comes back to how badly hampered the economy is because of this mishandled interest rate cycle,” El-Erian told CNBC.
At the March Federal Open Market Committee (FOMC) policy meeting, the central bank voted to raise the benchmark fed funds rate by 25 basis points to a target range of 4.75 percent and 5.00 percent.
The updated Survey of Economic Projections (SEP) (pdf) kept the 2023 median rate at 5.1 percent, suggesting monetary policymakers expect one more rate hike this year.
Powell told reporters he does not anticipate any rate cuts this year, adding that the rate-setting committee could even pull the trigger on a rate hike if necessary.
He also insisted that the American people can feel confident that their deposits are safe in the wake of the SVB and Signature Bank failures.
“We took powerful actions with Treasury and the FDIC, which demonstrate that all depositors’ savings are safe,” Powell told a post-FOMC meeting press conference. “The banking system is safe.”
Powell noted that it is too early to determine if the SVB and Signature failures will impact the U.S. economy.
Security guards and FDIC representatives open a Silicon Valley Bank (SVB) branch for customers at SVBs headquarters in Santa Clara, Calif., on March 13, 2023. (Noah Berger/AFP via Getty Images)
Some March economic data were published on Monday.
The Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) weakened to 46.3 last month, down from 47.7 in February and below the market forecast of 47.5. The S&P Global Manufacturing PMI contracted for the fifth straight month, coming in at 49.20, up from 47.3.
“Weak demand for inputs resulted in some relief for manufacturers as input cost inflation slowed again. A paucity of new orders sparked efforts to entice customers, however, as selling price inflation eased notably to the weakest since October 2020,” wrote Siân Jones, Senior Economist at S&P Global Market Intelligence, in the report. “Nonetheless, inflationary concerns weighed on business confidence once again amid pressure on margins.”