The US Fed should go beyond doubling its QE taper rate

Sadly, the shocking Consumer Price Index report for November was no exception. It corroborated other data pointing to an inflationary process that is stronger and more permanent than the Fed thinks.

Annual inflation rose from 6.2% to 6.8%, a level not seen since 1982 during the Paul Volcker era at the central bank. The main measure of inflation, which is supposed to exclude more historically volatile components – even though their impact on the most vulnerable sections of the population is particularly damaging – rose from 4.6% to 4.9%, a rate that increased over several decades. is the most.

After repeatedly protesting for failing to forecast this year’s rise in inflation and adequately adjusting their thinking based on updated and persuasive information, the few remaining inflation apologists on Friday were still “transient”. “Clinging to the idea of ​​drivers is already harmful. Price shock. In doing so, they fail to recall the increased likelihood of two events that are uncomfortably familiar to those who have experienced or studied past bouts of high inflation:

First, the question is not whether some of the more powerful drivers of inflation will lose their power; They definitely will. It is whether this happens when they sow the seeds for the broader inflationary dynamic they are already doing.

Second, the question is not whether this broader inflation dynamic will eventually reverse; This. Rather, it is about limiting the damage done during and after such reversals.

Historically, as the most powerful central bank in the world, the Fed has been at the center of both these questions, with consequent domestic and international implications. By failing to demonstrate a credible understanding of inflation and acting accordingly in a timely manner, the Fed itself could be causing uncontrolled inflation expectations. This creates a dynamic that is much more powerful and problematic than the original catalyst for inflation, which in this case is supply chain disruptions and a sudden lack of aggregate supply due to labor shortages. As inflation continues to rise and become more sustainable, there is an increased risk of not only an unnecessary economic downturn, but an outright recession as well. Historically, this has been the result of the Fed slamming on policy brakes in a late and disorganized attempt to regain its credibility and control over its inflation mandate.

All this undermines livelihoods in two unnecessary ways, both of which hit the poor particularly hard: first, by reducing purchasing power, especially for those who can least afford it, and second, creating unemployment.

The US Fed is already seriously lagging behind on grassroots development and related policy imperatives. As I’ve argued for months, it should have moved long ago to ease its foot from the ‘pedal-to-the-metal’ accelerator by curbing bond purchases in late spring and early summer. Instead, it merely kept repeating the mantra that inflation was fleeting and, in the process, undermined the steps taken by the Joe Biden administration to curb inflation.

Fortunately, the US central bank still has a window, albeit small and rapidly shrinking, to act in a systematic manner that minimizes undue harm to livelihoods. For that it will need to go beyond the current consensus policy call this week in three ways:

Be honest and transparent about why its inflation call is so inaccurate (which I characterized a few months ago as one of the Fed’s worst inflation calls, and one that risks a significant policy mistake).

Proceed with double the amount by which it reduces monthly property purchases.

Rather than emphasizing just another statement that a bond-buying taper does not indicate anything about future rate increases, acknowledge the possibility that it may have to raise rates soon after quantitative easing ends.

The Fed has an easy option this week. It can either continue with its gross mismanagement of inflation, or instead, begin to regain credibility and its control of the narrative over inflation and monetary policy.

If the US Fed opts for the former, its institutional position will become even more difficult, making its policy effectiveness more elusive in the future; The livelihood of many would be unjustifiably damaged; The already worrying inequalities of income, wealth and opportunity will worsen, and its internal divisions will widen.

Mohammed A. El-Erian is the President of Queen’s College, University of Cambridge and serves as the part-time Chief Economic Adviser at Allianz.