Opinion: Many people have lost faith in the Fed. Will it win our trust again?

Editor’s Note: Mohamed A. El-Arian is President of Queens College at the University of Cambridge, Renée Kerns Professor at the Wharton Business School, Senior Fellow at the Lauder Institute, and Advisor to Allianz and Gramercy. He serves on the boards of Barclays, NBER and Under Armour. The views expressed in this commentary are his own.

This week, it will become more apparent to economists and policymakers around the world that the Federal Reserve is in a catch-22 position of its own making. Due to concerns about high and persistent inflation, the Fed is likely to go down in history as raising interest rates by the same large amount in three consecutive policy meetings. But because it is doing so in a weak economy, it will face criticism for hurting not only domestic economic well-being, but also global growth.

This unfortunate situation the Fed is in – damned if you do, and damned if you don’t – exemplifies a deeper issue. Having missed the window when a “soft landing” was possible for the economy, (that is, reducing inflation without causing much damage to the economy), the Fed now finds itself far away from the world of “first-best” policymaking. In other words, instead of the highly effective, timely and well-targeted measures at its disposal to fight inflation, the Fed has ended up in a world in which nearly all policy actions can cause significant collateral damage and unintended adverse consequences. can. Many politicians, companies and families run the risk of thinking of the Fed as part of the problem and not as part of the solution.

What is the probability of getting the third consecutive record 75 basis points This growth comes against a backdrop of detrimental growth in living standards that are expanding in scope and, making things worse, becoming more embedded in the structure of the economy. title inflation, currently at 8.3%, may be falling, but the core rate, which does not include more volatile categories such as food and gas, is still rising. And it is the latter, currently at 6.3%, that measures the breadth and potential persistence of inflation.

Still, for nearly the entire last year, the Fed has consistently downplayed the threat of inflation. Meanwhile, the economy was conditioned to operate under zero interest rates; And the markets continued to be comforted by repeated Fed interventions to offset the decline in equity prices (the so-called “Fed puts”).

But it wasn’t until late November last year that the Fed stopped repeatedly assuring us inflation was “temporary”. just a few months ago, it was still pumping liquidity When inflation was increasing rapidly in the economy.

Now, the Fed has realized that it has been too slow to respond. By allowing inflation to become more underlying – or, as the chairman Jerome Powell The Fed must now be much more aggressive than it is now, if it were to respond in a timely manner — to “spread through the economy,” said last month. The Fed needs to avoid another blow to its already damaged reputation and policy credibility.

Instead of leading markets in battling inflation, the Fed has been forced to follow them. Until Powell’s hawkish pivot last month Jackson Hole Economic Symposium, it was forced to revise policy guidance time and again to make it in line with the indications of the markets. Coming to terms with seemingly endless one-sided revisions to key economic forecasts (high inflation and low growth), unfortunately this has led to the Fed’s economic and financial role scrambling from credible leader to lag behind.

Still, because it is too late to respond, the Fed will aggressively stomp on a weakening domestic and global economy. Thus, many economists have warned that the Fed will drive the US into recession; And a growing number of foreign policy makers complained that the world’s most powerful and systemically important central bank was poking out from under an already weak global economy. This is a far cry from the Fed’s well-known role in helping to avoid a highly damaging global recession in both 2008-2009 and, more recently, 2020.

This week’s policy action may well end in three distinct parts of our economy’s history books: the Fed raised rates 75 basis points for the first time in three consecutive meetings; Another component of the central bank’s biggest policy mistake in several decades; And an unusual example of a developed country’s central bank finding itself in a policy hole that is more familiar to some peer institutions in the developing world.

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