The Fed came under intense criticism for its delayed response to inflation last year, stepping in to raise interest rates when annualized inflation was already at 7.9%. Many critics targeted Fed Chair Jerome Powell, who along with several other top officials, had said in 2021 that rising prices were only temporary.
One of Powell’s most ardent detractors is Mohamed El-Erian, an economist and president of Queens’ College, Cambridge. El-Erian’s latest advice to Powell is about optics and how to avoid making a bad situation worse.
“The least-bad option now consists of holding off on interest-rate hikes and being honest with the market about where interest rates are going. The Fed needs to maintain consistent communication,” El-Erian said in an interview with Barron’s published Thursday.
El-Erian, who has long spoken about how high interest rates risk hurting markets, said in the interview that the stock market has been especially jittery and that Powell’s public comments tend to send markets spiraling.
El-Erian says Powell “isn’t sticking to the script” and that it’s causing economic damage. When asked what advice he would give Powell, El-Erian cited lyrics from the Broadway musical Hamilton: “Do you know that line from Hamilton? Talk less, smile more.”
A matter of word choice
It isn’t the first time El-Erian has criticized the Fed’s messaging. Last month, he slammed Powell in a Bloomberg op-ed for making gloomy statements that fueled “considerable volatility in markets that could risk both economic well-being and financial stability.”
For the past year, Powell has steered clear of saying he would slow or reverse interest rate hikes anytime soon, and that may be doing more harm than good.
El-Erian said in his Barron’s interview that Powell’s press appearances are normally followed by periods of market volatility that are far worse than those experienced by any of his predecessors. The vast power Powell’s words hold over the market was charted in a paper published last month by the Centre for Economic Policy Research’s VoxEU, a European nonprofit. The paper found that Powell’s press conferences have had an “outsized role in shaping recent market expectations,” leading to volatility that is at least three times as high as what other Fed chairs have presided over, while Powell’s specific choice of words was “systematically linked” to market reversals.
Last month, Powell somewhat moderated his tone after multiple bank failures threatened to spark a financial crisis. Meanwhile, Minneapolis Fed Chair Neel Kashkari warned in March that while banks are generally well capitalized, the crisis “definitely brings us closer” to recession.
Powell has said the bank failures might still cause banks to reduce lending, but also indicated that there could be a silver lining in that the Fed may no longer need to hike rates as quickly and may even be able to pause the hikes sometime this year. In one hopeful sign, the rate hike the Fed approved in March was lower than what some analysts had predicted before the banking crisis began.
In a Project Syndicate op-ed published Monday, El-Erian reiterated his point about the Fed’s poor communication, writing that its messaging “fueled rather than calmed market volatility on several occasions.”
Reconciling the Fed’s mandate to reduce inflation with what investors are saying about interest rate hikes over the next few months will be key to determining Powell’s legacy, El-Erian said in his interview. While it may not be an easy path for the Fed to navigate, it will be worth it in the long run, he said.
“The bad news is that we are on a bumpy journey. The good news is that it’s a bumpy journey to a better destination,” El-Erian said.
