Bond chief Mohamed El-Erian warns of dire consequences if the Fed continues its present course:
Look for the Fed in the next few weeks to go further in revising down its job, growth and inflation forecasts for 2012. Given the institution’s dual mandate of price stability and maximum employment, this will inevitably raise expectations of additional policy activism.
Having exhausted long ago the effectiveness of traditional monetary policy tools, the Fed has no choice but to consider another mix of unconventional measures – specifically, additional purchases of securities, a lower interest rate on excess reserves, an even more aggressive communication policy, and enhanced access to the discount window.
But, more of the same will not have a durable beneficial impact, especially if other policymakers remain missing in action. Indeed, the advantages of another round of unusual Fed activism are declining while the risk of both collateral damage and unintended consequences is material and growing.
I’ve mentioned it before but this looks like a good time to remind you of it. Here’s an example of the “collateral damage”: the insurance industry is having serious problems due to the Fed’s actions. There are, essentially, two ways of making money in the insurance business. You can make money by investing the premiums you take in, usually in certificates of deposit or bonds, or you make money in the form of commissions. To increase the amount of money made in commissions premiums must rise. There are limits to how far premiums can rise without people dropping coverage, hence collateral damage.
This sounds like a good time to return to our old friends, Alphonse and Gaston:
Mr. El-Erian and Dr. Bernanke want the Congress to move first with fiscal stimulus. Congress wants Dr. Bernanke to move first with monetary stimulus. The obvious alternatives for fiscal stimulus, mostly “tax cuts for the wealthy”, are deeply distasteful to the Congress, particularly to the Democratic leadership who’ve obviously convinced themselves that increasing taxes will be good for the economy or, at least, that’s what they’ve been selling to their constituents.
There won’t be any action from the Congressional side until after November and the posture of the Fed appears to be watchful waiting.