Armed with some of the most significant tools to influence the US economy, the Federal Reserve still cannot resolve this economic crisis on its own.
As inflation data and unexpected signs of a cooling labor market, speculation regarding the Fed is dominating the conversation. For good reason, as Chairman Kevin Warsh has noted, the Fed is incredibly powerful. However, there are limits to what it can realistically accomplish.
That is what Mohamed El-Erian, chief economic adviser at Allianz, reminded us on Friday as the market reevaluated its rate-setting expectations: The Fed is important, but fiscal policy is also vital.
We may still anticipate a series of rate hikes—as these actions typically occur in cycles—but looking at the bigger picture, it is clear that the Fed cannot resolve geopolitical conflicts or clear supply chain bottlenecks. (Rate expectations have shifted significantly from a week ago, when an October hike was considered likely. As of Friday afternoon, there is an almost 80% probability that the Fed will keep rates steady.)
“Monetary policy should not be the only game in town,” El-Erian said on Yahoo Finance’s live morning show The 8:30. “This is a role for fiscal policy.”
A primary issue poorly suited for the Fed to address is the deficit. Central bankers do not manage government spending, yet it remains a crucial element of the bond yield dilemma. Although the Fed is frequently urged to stabilize the struggling bond market and its rising yields, Washington’s inability—or lack of interest—in curbing spending deserves equal scrutiny.
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It is not just that the Fed lacks the power to magically reduce spending or increase tax revenue. El-Erian argued that the tools the Fed uses to manage the fallout from higher government debt can actually worsen economic challenges.
“I worry that we’re going to get too much monetary, too many hikes, too few fiscal policy measures. And then we’re going to have to deal with this very uneven economy and an even more pronounced K,” he said, highlighting the shape of the economy where the “haves” fortunes surge while the “have nots” fall.
