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Powell’s Tricky Balance at Jackson Hole

Mohamed A. El-Erian

(Bloomberg Opinion) -- It is often easier – though not necessarily easy – to talk about what policymakers should say rather than what they will say. This week may be an exception.

I suspect that Federal Reserve Chairman Jerome Powell, opening the annual Jackson Hole symposium on Friday,(1) will try to reset expectations to keep the central bank’s policy options wide open.

This would start by walking back the July 31 reference to a “midcycle adjustment” and instead opening the door for an interest-rate-reduction cycle. He would couch this in terms of the challenges for the U.S. economy of the unusual growth divergence facing the advanced world – i.e., the contrast between a robust U.S. economy and growing weakness in Europe and Asia – as well as the need to insure against the detrimental effects of protracted trade policy uncertainty. All of which would open the way for him to warn against overreactions to an inversion in the U.S. yield curve. Finally, he would throw in a couple of sentences reiterating the importance of the Fed’s political independence when it comes to the conduct of monetary policy.

But is that what he should say?

Powell takes the stage on Friday at a time of unusual uncertainty for the Fed, as well as other systemically important central banks such as the European Central Bank. Policy effectiveness, especially in terms of supporting economic growth and attaining the inflation target, is increasingly doubted by markets, undermining the potency of forward guidance. Puzzles regarding key economic relationships are yet to be solved decisively – particularly a world of a persistently and unusually low unemployment rate without more robust wage growth, inflation and labor force participation. Trade uncertainties cloud economic models already challenged by structural shifts in the U.S. and global economies.

Political and market pressures are not helping. Both are pressing hard for a path of lower interest rates that exceeds what Fed officials seem willing (and some would say able) to do, as well as what would be strictly warranted by economic developments and prospects. Amplifying all this is a recent history of some unfortunate Fed communication slips.

So, on the one hand, there is a good case for Powell taking on more forcefully markets and pressure coming from the White House. After all, the Fed alone cannot deliver the outcomes that both are ultimately looking for: sustainably higher economic growth and genuine financial stability. For that, the central bank needs to hand off the primary policymaking responsibility (which it has carried virtually alone for way too long) to other government entities that have tools better suited for the task at hand. If it doesn’t do so soon, its policy’s benefit-cost-risk equation will turn more net negative; and it will be blamed not just for failing to deliver high growth but also for fueling longer-term financial instability.  

On the other hand, taking that stance risks fueling immediate market instability and aggravating White House anger. Which implies that on Friday, Powell should instead say little or nothing about the prospects for monetary policy.

Recent history suggests that, even when the Fed moves in the direction sought by markets and the White House, both press for even more, and they do so regardless of what’s warranted by economic facts. This also threatens the credibility of the central bank. The Fed, already is in a lose-lose situation, sees its prospects further complicated by the risk of another communication mishap, regardless of  what it ends up saying.

No wonder a growing number of observers wonder whether central banks should revisit the mantra that more communication and policy transparency are always better – a traditional wisdom that led Powell to increase the frequency of press conferences to hold one after every FOMC meeting. In the meantime, investors should prepare for the discomfiting reality that the era of a market-soothing Fed could well be coming to an end. Having been excessively viewed as an effective repressor of volatility, the Fed may now be increasingly become seen as a risk to financial stability.

(1) Over the last 10 years or so, this central bankers’ exclusive confab in the mountains has tended to be used to signal major policy changes and hold rather academic discussions on challenging policy issues. Most notably, in August 2010, then-Chairman Ben Bernanke spoke to the why and the what of using unconventional monetary policy, like quantitative easing and persistently ultra-low policy rates, to pursue economic outcomes that went well beyond those related to the normalization of badly malfunctioning financial markets. In 2011 and 2014, the overall themes dealt with “maximum long-term growth” and “labor market dynamics.” In 2015, it was “Inflation Dynamics and Monetary Policy.” This year, the general topic is also apt: “Challenges for Monetary Policy.”

To contact the author of this story: Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."

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