Taps Coogan – December 21st, 2022

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Mohamed El-Erian, Allianz Chief Economic Advisor, recently spoke with Bloomberg about how the Fed will navigate tightening in light of economic weakness.

 

El-Erian:

“I think they are going to overtighten and they are not going to acknowledge that in a world where the supply side has become the main issue, a 2% inflation target doesn’t make total sense…”

“It is impossible to increase an inflation target you have missed consistently. Argentina tried that… But what they are going to try to convince us is that we can stable inflation at 3%-4% and it’s not the end of the world… The alternative of crushing the economy is much worse… They’re in trouble… You’ve had two horrible years for the Fed and it’s not that easy to get back on side…” 

El-Erian has been remarkably on point for the last couple years, warning for most of 2021 that inflation was coming, wouldn’t be transient, and that the Fed needed to start tightening way earlier.

Here however, I think he is making a mistake. He is assuming the Fed will settle for an informal, temporary 3%-4% inflation regime because continuing to aggressively tightening until inflation reaches 2% would be too economically devastating. While it would be devastating, that doesn’t mean the Fed won’t do it. This has proven to be a stunningly error-prone Fed and, given the lags in monetary policy and CPI, it seems more likely than not that they will keep tightening with the goal of getting to 2% ‘immediately’ as opposed to pausing at mildly restrictive and letting inflation work down without a crisis.