The "Fed Failed on Inflation" Industry...
Tell Mr. El-Erian (and others) to focus on fixing fiscal -- not monetary -- policy...
From Mohamed El-Erian (He/Him) • • President at Queens' College, Cambridge on LinkedIn: The cover of The Economist.
There is an industry out there now around how the Fed failed on inflation, and Mohamed El-Erian has been a prominent part of that. Perhaps give it more time to see how the Fed's strategy pans out.
On public finances, while I am not advocating using inflation to flatter your government debt to GDP ratio, if you get an inflation surprise that does not de-anchor inflation expectations, then D/GDP ratios improve. This can give you some more room to adjust poor public finance settings (which the US suffers from) toward fiscal consolidation over the medium term.
In my view, woeful public finances are a bigger challenge for the US right now than monetary policy credibility, though the two are related. Fiscally driven inflation — by way of central bank financing of deficits — is historically a more pernicious inflation driver around the world.
Without action on the fiscal front, monetary policy credibility can be compromised. Fiscal dominance occurs when monetary policy is constrained by worries that rising rates will damage sovereign creditworthiness. So, let's focus on the right problem.
The IMF WEO data published Tuesday show the US general government debt to GDP ratio falling from 134% in 2020 to below 124% in 2023 due to a rise in the GDP deflator, aka inflation, and some modest, natural post-pandemic fiscal consolidation.
The IMF seems more optimistic about the Fed going forward than the naysayers. This is reflected in their forecast of an increase in the GDP deflator by an average of 5.2% in 2021-22, before falling back to 2.3% in the subsequent 5 years on average. This is near the inflation target (albeit a different inflation gauge), even though the Fed's Flexible Average Inflation Targeting (FAIT) monetary policy framework, announced in 2020, allows room to exceed 2% when inflation has fallen below the target for a while. Inflation fell below 2% in about half the decade up to 2021.
Inflation could get out of control, true, so caution is needed. But, exercise caution as well in your criticism of monetary policy. And, focus the discussion instead on getting CBO recommendations for fiscal consolidation over the medium term implemented.