REUTERS/Daniel Munoz
- The Fed's handling of the economy has badly hurt its reputation, Mohamed El-Erian said.
- El-Erian has criticized the Fed's inflation response, which has sparked fears of recession and cause pain in markets.
- The economy could soon face a recession or stagflation if the Fed doesn't correct its mistakes, he said.
The Federal Reserve has botched its handling of the US economy, and its reputation has been badly damaged as a result, according to economist Mohamed El-Erian.
In an op-ed for Project Syndicate on Monday, the Allianz chief economic advisor pointed to the Federal Reserve's failings over the past year in addressing higher inflation. The problems chiefly lie in the Fed's delayed response to inflation, he said, as central bankers dismissing rising prices as"transitory" in 2021 before being forced to aggressively hike rates in 2022 as prices stayed high.
But those rate hikes have started to wreak havoc on the economy as the liquidity that once ballooned asset prices is rapidly withdrawn. Stocks tumbled from their highs of 2021 and fell 20% last year. More recently, the Fed's rate hikes have hammered the banking system, with the collapse of Silicon Valley Bank last month illustrating the risks to US banks as they sit on large amounts of fixed income securities that have decreased in value.
The situation hasn't been helped either by the Fed's inconsistent communications to markets and the broader economy, which often walk the line between dovish and hawkish messaging. According to the Centre for Economic Policy Research, market volatility is three times greater when Fed Chair Jerome Powell speaks.
All of that looks reflects poorly on the central bank, which, in addition to being wrong in its inflation outlook, now looks like it could potentially be guiding the economy into a hard landing scenario, experts say.
And the bruised reputation of central banks spells trouble for the economy on its own, El-Erian said, as the public's lack of trust in the Fed to control inflation and financial stability could cause both to spiral.
"The Fed's problems should worry everyone. A loss of credibility directly affects its ability to maintain financial stability and guide markets in a matter consistent with the dual mandate of maintaining price stability and supporting maximum employment," El-Erian said.
Cracks are beginning to show on the surface, warning that the Fed has already undermined its own credibility. According to El-Erian, there has never been a time when markets have so strongly dismissed the Fed's forward-guidance for the economy. Central bankers and markets are pricing in different inflation expectations that have spread as far as a full percentage point, he noted.
But the Fed can still repair its image, El-Erian said. The economist has previously noted a recession wasn't completely inevitable, and he's urged central bankers to "right the ship" by incorporating more diversity in their viewpoint, such as by adding two external voting members, and taking accountability for its mistakes over the past year.
Failure to correct course could lead to stagflation, the economist has warned, a point echoed by other downbeat commentators. "Dr. Doom" Nouriel Roubini has predicted a stagflationary debt crisis ahead, which he says will combine the worst aspects of 1970s stagflation and the 2008 crisis.