The Fed as ‘Oz, the Great and Powerful’

By Mohamed A. El-Erian

Disney's "Oz the Great and Powerful," a bold extension of the classic "Wizard of Oz," opened to audiences nationwide this weekend. Judging from my family's reactions, Disney (DIS) has a success on its hands. And while watching it, I found myself drawing parallels with the Federal Reserve's attempt to promote growth and jobs - not only because of what the Fed is doing and how, but also because success ultimately depends on the same theme that is critical for the movie's happy ending.

Similar to "Wicked," the smash Broadway play, the new movie is positioned as a preamble to the "Wizard of Oz." But rather than provide us the perspective of the witches, it tells the story of the wizard - his unlikely trip from Kansas to the Land of Oz, and the manner in which he deals with a role that is initially thrust on him but he then accepts rather willingly ... and, ultimately, succeeds at it.

Some details about the move (and hopefully without playing the role of spoiler for those who intend to see it).

The wizard faces seemingly insurmountable odds. Rather than genuine magic, all he has are show tricks that worked pretty well in much easier and more controlled circumstances. He has to counter frightening and dangerous animals and, of course, two nasty and cunning witches with considerable power to disrupt and destroy.

Through the use of astute illusions (though no details will be provided here), the wizard mobilizes the population of Oz, convincing them that they have the ability to control their destiny for the collective benefit. In the process, he gets them to focus on what they do well, showing that coordinated action is multiplicative rather than just additive. And with the courageous support of a good witch, Glinda, they all manage to chase away the two nasty witches and their allies (acknowledging, however, that they remain dangerous and will likely be back one day).

The Great and Powerful ... Fed

When you think of it, in today's economy, the role of the wizard is being played by the Federal Reserve Bank. Facing a difficult economic situation, made worse by the inaction of a bickering Congress and essentially paralyzed government agencies, the Fed has found itself forced to take on the role of savior. And since its massive emergency interventions in 2008, it has felt a moral obligation to stay engaged, a role which, over time, it seems to have pursued more willingly.

In trying to do good, the Fed has confronted more than the considerable dark forces of disorderly economic and financial deleveraging. It has also had to overcome the (not-so-occasional) headwinds from a disruptive Congress and a Europe unable to decisively overcome a regional debt crisis.

Also, similar to the wizard, the Fed has had limited tools at its disposal. Unable to get to the heart of the economic dislocations and disruptions, it has shrewdly adapted imperfect tools that have been only known to work in more controlled environments. Their success depends on getting the collective to believe.

By artificially and consistently raising financial asset prices, the Fed hopes to get the various segments of the population to do what they do well ... and, collectively, deliver growth and jobs. Specifically, by causing genuine excitement about a record-setting stock market, it hopes to trigger animal spirits and wealth effects, thus inducing those holding lots of cash to invest and consume; and through artificially-low interest rates, it is subsidizing debtors and taxing creditors.

Finally, like the wizard, the Fed understands that this is not the end of the story. The victory of the collective is only sustainable if it is followed by other actions that address the heart of the problem.

Where's Our Happy Ending?

This is the reason why Fed officials have joined the President in advocating measures that promote economic growth, create well-paying jobs, and provide for a permanent safe deleveraging of over-indebted segments. The specifics include productivity-enhancing structural reforms, steps to improve the functioning of the labor market, a medium-term tax and spending revamp, and a safer and sounder financial system.

Disney was able to deliver a happy ending - one that led our nine-year-old daughter to declare that the movie is "a 10" (she has given 9.9's a few times, but never a 10). Will the Fed also succeed?

The Fed has registered some encouraging successes recently. Data releases, including Friday's important jobs report, confirm that a growing number of segments in the U.S. economy are healing. Having seen the stock market surge through its previous record, more and more people believe that the Fed will be able to deliver a much better macroeconomic outcome, and do so despite Congressional dysfunction that continues to create avoidable headwinds.

But it is too early to declare victory. Recent successes, while notable and highly welcomed, have yet to constitute the critical mass the economy needs to attain escape velocity.

Like the Wizard, the Fed needs crucial help at a critical time.

Some are hoping that the economic equivalent of Glinda could come in the form of a robustly expanding China and/or a stabilized Europe. Personally, I doubt that an external factor would do it. Rather, the catalyst needs to - and can/should - come from within the United States.

From a policy perspective, a well-functioning and more cooperative Congress is best placed to produce this catalyst in two ways: by avoiding additional headwinds, and by working with the Administration to implement the above-mentioned reforms that informed citizens know are in the longer-term interest of the country. This is particularly so if we wish to maintain the important economic run of each successive generation being better off than that of its parents.

Dr. El-Erian is CEO and co-CIO of PIMCO and is based in the Newport Beach office. He re-joined PIMCO at the end of 2007 after serving for two years as president and CEO of Harvard Management Company, the entity that manages Harvard’s endowment and related accounts. Dr. El-Erian also served as a member of the faculty of Harvard Business School.