Second, the Fed needs to show that it is serious about tackling inflation, not just in words but in actions. Having so mishandled the run-up to this week’s Federal Open Market Committee meeting, it has no choice but to raise the target for the fed funds rate by 75 basis points, thereby undermining its own forward policy guidance of 50 basis points signaled just last month and doing something that Fed Chair Jerome Powell had ruled out.
Third, in raising 75 basis points, it must also credibly convey the notion that this is part of a journey, and it must avoid repeating the mistake of spurious precision—an unforced error that it has made a couple of times in the last few months.
Notwithstanding the fact that it operates in a more difficult context because of the weaker regional economy and the risk of “spread fragmentation,” the European Central Bank has recently taken some important steps in this regard. The longer the Fed delays in doing the same, the more markets will revise upward inflation expectations and the scale and speed of the rate-increase cycle. The result of that, should it materialize, will be the current U.S. stagflation baseline giving way to recession; and, once again as economic insecurity increases because of both higher prices and more uncertain income prospects, the most vulnerable segments of the population will be hit hardest.
I warned a year ago that, in insisting that inflation was “transitory,” the Fed was risking one of its biggest policy mistakes whose consequences would be felt beyond the U.S. economy. Since then, it has been like watching a bad dream play out in stages. I hope that the Fed will use this week’s FOMC meeting to break out of the problematic policy regime it has placed itself in, thereby avoiding yet more undue damage to economic well-being, prospects and social equity.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. A former chief executive officer of Pimco, he is president of Queens’ College, Cambridge; chief economic adviser at Allianz SE; and chair of Gramercy Fund Management. He is author of The Only Game in Town.