From Pimco’s chief executive…
While it may not rank quite as high as his appearance on the US news show ’60 Minutes’ a few months ago, Chairman Bernanke’s Op Ed in today’s Wall Street Journal is nevertheless notable and important. It represents a bold attempt by the Federal Reserve to reach out broadly and pre-empt mounting concerns about the challenges facing monetary policy.
Bernanke’s bottom line is clear: “Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so.” In making the case, Bernanke seeks to, first, differentiate between what the FT’s Krishna Guha has labeled the ‘when’ and the ‘how’ of monetary policy after a period of extreme activism; and second, to provide indications that the Fed can manage both in an orderly fashion.
Put another way, Bernanke is signaling that the Fed is aware of the need to re-assure markets of its ability to strike that delicate balance between deflationary and inflationary concerns. To this end, and on the ‘when,’ he reiterates that the currently accommodative interest rates will be required for ‘an extended period.’ On the ‘how,’ he notes that the eventual exit will involve using both price and quantity-based measures to eliminate the large reserve balances that banks currently hold at the Federal Reserves, and/or to neutralize their impact.
Bernanke also reminds us, and correctly so, that some of the Fed’s special credit facilities will wind down automatically over time. Finally, he re-iterates the importance of protecting the ‘independence of monetary policy.’
While all this is important, it does not constitute major news as such. Indeed, Bernanke has today confirmed a view that has increasingly prevailed in financial markets: there will be no early hike in interest rates; and when the time comes to tighten monetary policy, the sequence will involve dealing first with the excess reserves. Yet this is not sufficient to ensure that the US is indeed able to balance well deflationary and inflationary risks.
To move from a necessary condition to one that is both necessary and sufficient, one must also consider what, increasingly, is the large elephant in the room when it comes to policies — namely, the design and conduct of fiscal policy. This is an area where challenging short and longer-term imperatives need to be reconciled over time, and at several level of local, state and national governments.
Indeed, Bernanke’s speech is yet another indication of an important ongoing transition in US policymaking: After being heavily involved in stabilizing a highly disrupted economy, the Fed is transitioning from the driver seat to the passenger seat.
By virtue of its greater flexibility and responsiveness, the Fed ended up assuming the main role in responding to the crisis, with fiscal and other agencies (including the FDIC) playing important support roles. It is now the turn of the fiscal agencies to assume the main role, with the Fed and others playing the support roles.
Bottom line: we have now entered the phase where fiscal policy is the more important determinant of the ability of the US to balance the risks of deflation and those of inflation. And, here, the jury is still out.
Mohamed A. El-Erian is chief executive and co-chief investment officer of PIMCO. His book ‘When Markets Collide’ won the 2008 FT/Goldman Sachs Business Book of the Year.
Related links:
If a central banker screams in a forest… – FT Alphaville
Mohamed El-Erian – “The crisis is morphing again” – FT Alphaville