Taps Coogan – December 8th, 2023

Mohamed El-Erian, Allianz Chief Economic Advisor and Queen’s College President, recently spoke with CNBC about his view that the Fed should formally adopt a 3% inflation target as, in his eyes, the path to 2% includes too high of a risk of recession.

El-Erian:

“There is a market romance right now with the softest of soft landings. I think that’s probably too much of a romance, but it is one that has led to the biggest loosening of financial conditions on record… You’ve heard me say over and over again that they (the Fed) should have stopped before the last hike. I wouldn’t go as far as the market to price in a 50% chance of a March cut and five cuts next year unless you believe we are going into recession and if you believe we are going into recession equities should be where they are… 

“The best of the inflation move is behind us after this month. We have one more month of good inflation data and then it gets a lot tougher. My hope… is that the Fed targets 3% inflation not a 2% inflation and that would allow us to soft-land the economy… I really worry that a 2% inflation target means not only sacrifices in growth that we shouldn’t make but sacrifices in equality that we should make… It is very difficult to get back to 2% as quickly as the market thinks we are going to get back to 2%…”

There are times when yours truly agrees with what Mr. El-Erian has to say. This is not one of those times.

Sure, getting from 3% to 2% will take a further slowdown in growth (perhaps a recession) and, yes, the market is disregarding the difficultly of that path. However, the notion that the Fed should therefore give up and target 3% inflation is silly.

Recessions happen. In fact, they happen often. At some point, probably beginning in the Greenspan era and then reinforced by the Global Financial Crisis, economists and policy makers started to view recessions at apocalyptic events that needed to be avoided at all costs. That absurdity got us trapped in nearly 15 years of entirely unproductive ultra-accommodative policy that laid the foundation of our current problem with inflation and excessive debt, a problem that ironically makes recessions more existentially dangerous. 

The Fed needs to get inflation down (all the way to zero if it was up to me). How quickly the Fed gets inflation back down is a discussion. Avoiding a severe recession that resets monetary policy at ultra-accommodative levels is critical but the ideal path may very well involve a mild recession that reminds everyone what good monetary and fiscal policy actually entails: prioritizing the long term structural health of the economy even if that means some short term discomfort.