By Mohamed A. El-Erian
(Bloomberg News) Count me among those who believe that the latest statement from the Federal Open Market Committee upgraded the outlook for both growth and inflation in the U.S. Yet, what may prove much more significant about the statement lies in what it didn't cover: namely, Japan.
In its usual concise manner, the FOMC informed us this week that America's economic recovery "is on a firmer footing" and that inflation is facing "upward pressure." The hope is that the former will prove durable and that the latter will be transitory though neither are certain.
The statement was silent on the implications for the U.S. of the tragic disasters in Japan, the world's third-largest economy. I can think of two principal reasons for this.
The FOMC may have lacked the information required to take even a preliminary position. After all, the group met only a few days after the earthquake and tsunami hit Japan. Much of the background material for the meeting was prepared before those awful events. Moreover, uncertainty prevails after such disasters. Indeed, the Japanese authorities themselves don't yet have a good handle on the extent of the damage, and the continuing instability of several nuclear reactors materially increases the uncertainties.
A second interpretation is that this important policy-making body believes that the economic impact of Japan's disasters on the U.S. will be transitory. As such, it would be legitimate for policy makers to "look through" the tragedy when assessing the implications for the U.S. economy.
Assessing the Impact
This sanguine view could sound heartless and absurd in light of the horrific images of human suffering and physical damage. Yet it has also been expressed by some economists who have used the 1995 Hanshin (Kobe) earthquake as a valid, legitimate reference.
Through this prism, the aftermath of Japan's natural disasters will be dominated by large reconstruction spending. Growth resumes in a V-shaped fashion, and the initial (shortage-driven) inflationary spike is normalized as supply chains are restored. As such, it would be imprudent for the FOMC to react to the immediate economic impact of the disasters since it will prove temporary and reversible.
Once rescue operations are complete, Japan will indeed embark on a massive reconstruction program that, I believe, will be successful. Yet there are three reasons why it's way too early to conclude that the aftermath of these events will have only a transitory impact on the global economy.
Chilling Consequences