Mohamed El-Erian, the chief economic advisor of Allianz and chair of Gramercy Funds Management, has alerted that the Federal Reserve cannot hit its 2% inflation goal without damaging the U.S. economy. The economist proposed a higher stable inflation rate of between 3% and 4%.
Markets have reacted to the news and investors are beginning to accept that inflation rates are likely to remain higher than the Federal Reserve’s goal for a longer period of time. Kenneth Rogoff, a professor at Harvard University and former Fed economist, told Bloomberg Television Tuesday that “Back in the day, they should’ve said 3% instead of 2%,”.
El-Erian, who is chairman of Gramercy Funds and a Bloomberg Opinion columnist, has warned that the Fed’s “data-dependent” approach is insufficient when it comes to dealing with supply-side developments such as energy transition, changes in supply chains due to the pandemic, a tight labor market, and shifting geopolitical issues. He believes that the most likely scenario is that inflation remains “sticky” and settles around 3% or 4%.
However, El-Erian cautioned that the Fed could not just change the inflation target when it has “missed it in such a big way”, as it would be a hit to the Fed’s credibility. He urged the Fed not to fall back into “complacency” and warned that “simplistic economic narratives…that entice those looking for shortcuts, often mislead much more than enlighten.”
The market is expecting the Fed to raise rates at least two more times this year. But according to Dominique Dwor-Frecaut, senior macro strategist at Macro Hive, the Fed funds rate could reach up to 8%, which has not been seen since 1985.
As the debate about the inflation target continues, El-Erian is clear that “the worst thing we can do is fall back into complacency.” Whatever happens, he says, “we need a view of where we’re going.
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