(MENAFN-Jordan Times)
CAMBRIDGE – On the 40th anniversary of her accession to the throne, Queen Elizabeth II said: “1992 is not a year that I look back on with unalloyed joy. In the words of one of my more sympathetic correspondents, it turned out to be an annus horribilis”. The late monarch’s now-famous speech followed a year of unpleasant developments for the crown, including a fire at Windsor Palace, the end of the marriages of two of their children (with a third royal separation due to be made public the following month) and various leaks.
The Queen’s admirably open and honest admission of these difficulties helped cement another three decades of tremendous national and global respect for the monarchy. At the start of a new year, the US Federal Reserve, trying to put behind its own second consecutive annus horribilis, would do well to follow suit. This is the Fed’s best chance of regaining its political credibility, restoring its reputation and reducing its vulnerability to inappropriate policy intervention, all of which will be critical to its effectiveness and therefore to the broader economic well-being.
Over the past two years, the Fed has been terribly wrong in its assessment of inflation. His forecasts were so far off the mark that some former Fed officials have publicly and repeatedly dismissed them, a most unusual occurrence. As a result, policymakers missed the opportunity to take timely action to stem the price hikes that have since eroded everyone’s spending power and hit the most vulnerable sections of society hardest.
Worse, even after realizing its mistake, the Fed made another mistake in November 2021 by not reacting quickly enough. Only in March 2022 did it stop injecting liquidity into an increasingly inflationary economy; and its first rate hike this month was a modest 25 basis points.
Economists and markets are increasingly concerned that these compounding errors have set the stage for another error. As the world’s most powerful central bank has been forced into its most anticipated and fastest growth cycle in decades, and at a time when the economy is already slowing, there are growing concerns that this will tip the US economy in an unnecessary direction toward recession.
The Fed’s poor performance isn’t limited to its analysis and policymaking either. Communication also leaves a lot to be desired. More than once in the past two years, the Fed has made rather unwise, off the top-notch remarks, such as when it indicated in July that its interest rates were already at neutral levels. This comment soon proved utterly naïve and understandably drew widespread criticism, including from former US Treasury Secretary Lawrence H. Summers, who called it “analytically unjustifiable” and pointed to the persistence of “wishful thinking”.
In its latest forecasts and last press conference of the year, the Fed went out of its way to signal to markets that its policy rate was likely to be 5.1 percent by the end of 2023. This forward guidance was backed by 17 of 19 Fed officials, but markets still haven’t priced it in. Instead, futures markets are pointing to a 4.4 percent policy rate and anticipate that despite what it has said, the Fed will be forced to cut rates over the course of the year to the contrary.
Then there were all the ethical gaffes. In the past two years, three senior Fed officials have resigned following reports that they engaged in shady stock trading practices during the pandemic, when Fed policy sent valuations skyrocketing. Then a fourth official admitted that he had violated trading rules and reporting requirements, and a fifth officer raised eyebrows when he agreed to speak at an invitation-only, confidential event organized by a major bank.
All of these developments obviously raise concerns about the effectiveness, standing and reputation of an institution that plays and must play an absolutely crucial role in both the US economy and the international monetary system. Not only do they weaken its authority, undermine the impact of its forecasts and undermine the effectiveness of its forward guidance, but they could also make it vulnerable to outside interference. This could further jeopardize the operational autonomy the Fed needs to fulfill its mandate.
Looking ahead, the Fed is unlikely to have done enough to erase its past inflationary mistakes. As inflation eases and will continue to do so, it will do so at the cost of undue damage to livelihoods. And having allowed inflation to become embedded in the structure of the economy, the risk remains that it will remain at a rate above the Fed’s 2% target later in 2023. In this case, the Fed must choose between equally uncomfortable policy options, all of which will become even more painful for society once the US has entered a recession.
To face such challenges, the Fed must step away from the failures of 2021-22. In addition to the equally important internal component, its task now has a decisive external component. It is for this reason that this important institution must take a page from the late Queen’s remarkable 30-year-old playbook.
Mohamed A. El-Erian, President of Queens’ College, University of Cambridge, is a professor at the Wharton School, University of Pennsylvania, and author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse (Random Home, 2016). Copyright: Project Syndicate, 2022.
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