There is a high risk of a recession in the United States due to the monetary policy of the Federal Reserve System (FRS, central bank of the United States), since inflation is very high and on the supply side there are structural changes that are observed in macroeconomic models. capture is not very good. This is the opinion of economist Mohamed El-Erian, chief advisor to the Allianz group and president of Queens College, University of Cambridge, UK.

In an interview with Estadão / BroadcastEl-Erian argues that the Fed is aware of the situation and will reduce monetary stimulus for the US economy at the end of the year, when high inflation has not dropped to the target level of 2% and will remain in the range of 4-5%. He believes that the reduction of incentives will begin no earlier than December and should last from 10 to 12 months. “The Federal Reserve should have already started this process. It is almost impossible to point to the benefits of buying $ 120 billion in financial assets a month at this time, ”he says. “After that, there will be an increase in interest rates, and the first increase will happen in 2023, which I think will be too late.”

According to the economist, the Federal Reserve is “held hostage to the wrong framework for monetary policy,” which is based on past evidence of inflation. However, it would be more pertinent to listen to comments from companies that indicate that costs are rising due to three factors: transport bottlenecks, labor shortages, and a shortage of raw materials. “These difficulties of a few companies will soon disappear, but they have price power as demand is so high.” Read the key interview excerpts below.

How do you assess the conduct of the Federal Reserve’s monetary policy, especially the process of phasing out the monetary stimulus program?

Last week, Federal Reserve Chairman Jerome Powell advised the market to wait for a later announcement of a cut in stimulus. Ahead of Powell’s press conference at the end of the Fed’s July meeting, there was a consensus that the US central bank could announce some measures in August or September and put them into effect in November or December. After this Powell conference, that expectation changed: the announcement was made in November or December, and the process was to start in January or March 2022. The Federal Reserve should have already started this process. Today it is almost impossible to determine the benefits of buying $ 120 billion in financial assets a month. Even the real estate sector is very hot. And the Fed continues to buy $ 40 billion in mortgage-backed assets. Nobody understands why they do it. There are costs and risks. First, we have an evolving inflation problem. This is not inflation, which is recorded in Brazil, but rather a 3% to 5% rate for an economy that usually goes below 2%. There are unnecessary economic risks involved. Bubbles continue to form in financial markets, which means that there is a risk of financial instability that could have negative consequences for the economy. When I look at all this, I wonder why the Fed is taking such steps. And that has implications for countries like Brazil, because if the US sneezes, emerging markets get colds.

Why do you think Jerome Powell waits too long to start reducing stimuli?

Inflation has been low in US history and Powell doesn’t want to look at it again. There is also a Covid-19 Delta variant that makes the economic scenario uncertain. Powell has reiterated that inflation is temporary, although he understands that inflation is getting higher and longer than he expected. Aside from the possible consequences of the Delta option, he is also concerned that a phenomenon similar to that recorded in the last quarter of 2018, when he tried to tighten monetary policy, but the financial market forced him to retreat, would occur. awkward.

In these circumstances, what are the chances that Jerome Powell will be re-appointed as Fed Chairman early next year by President Joe Biden?

He’s a favorite. Powell commanded a very strong response to last year’s pandemic-triggered economic crisis. The markets love you. And there is a risk that if the Fed changes its chairmanship, it could create excessive uncertainty in an environment fraught with doubt. But this is a political decision, and I do not know what it will be. On the other hand, I think its main vulnerability is that if it is not brought back quickly, say, in the next 2 or 3 months, high inflation could turn into a political problem that already exists, but it could become even bigger.

Are you skeptical that the rise in US inflation will not be temporary, as indicated by the Federal Reserve?

There was a problem. Macroeconomic models do not reflect structural change well. The US economy is undergoing a major structural shift on the supply side. The right thing to do right now is not to rely on macroeconomic models, but to listen to what companies are saying. I listen to companies every day and they point to three problems associated with increased production costs: one is transportation, the second is a shortage of workers, and the third is raw materials. The difficulties of a few companies will not end soon, but they have price power as demand is so high. We all know that these factors are causing inflation to rise. There are some elements of rising inflation that are temporary and reversible, such as the effects of statistical comparison on prices that fell sharply last year due to the pandemic, but even so inflation, as measured by the CPI (Consumer Price Index, in abbreviation in English) is 5.4% and the influence of statistical factors is less. And there is another inflation ahead, which has not yet entered the index. The claim that the lift is temporary does not match the facts that the companies describe. The Fed is changing the notion that inflation is temporary. For many, a temporary means a few months, but Powell pointed out last week that it could take 1-2 years. I don’t know how to estimate that inflation growth for 1-2 years is temporary. International Monetary Fund (IMF) forecasts show that US inflation will be above the 2% target over the next two years.

What could be the next steps by the Fed to stimulate monetary policy and interest rates?

I don’t believe the Fed will announce any action before December. I believe that the process of reducing incentives will take 10 to 12 months. After that, interest rates will rise, and the first increase will occur in 2023, which I think will be too late. The Federal Reserve is dependent on a new monetary policy framework that was completed in 2019 and looks to the past. The Fed indicates that it will only act in response to signs of inflation. In the US, there is no problem with the efficiency of aggregate demand, as several sectors are experiencing significant growth. The government is investing trillions of dollars in the economy, families have additional savings equivalent to 10% of GDP, and the corporate sector is performing very well and has good cash levels. There are problems with the aggregate supply. I think the Fed is hostage to the wrong system of monetary policy.

What should be the correct structure?

Listening to companies, collecting microeconomic data and designing a scenario developed using information from the fundamentals of economics.

Are there any risks that inflationary expectations will start to rise steadily?

We will see that inflationary expectations for the next 5 years will rise, and after this period they will fall. There has never been an episode in history where the Fed slowly tightened monetary policy and did not act to drive the economy into recession. What market agents will start to appreciate is that inflation is high, the Fed will need to tighten its monetary policy brakes, and when that happens we will have a recession. I believe there is a great risk of a recession. The longer the Fed waits, the longer it will take to grasp this situation. The Fed will wake up when high inflation does not drop to 2% by the end of the year and remains between 4% and 5%.

Do you think the US could be in recession in 2023 when the Fed raises interest rates again?

If we don’t have transient high inflation, but constant inflation, the Fed will need to accelerate the rate of decline next year. When this happens, markets will raise interest rate expectations and there is a real risk of a very rapid economic slowdown, which could occur between the second half of 2022 and early 2023.

How do you assess the fiscal stimulus adopted by the government of President Joe Biden to accelerate the recovery of the US economy?

Fiscal action fell prey to inadequate Fed policy. In recent months, the US economy has been growing, the fiscal accelerator has worked, as has the monetary policy accelerator. Now we are going downhill, the monetary accelerator is on, as is the financial accelerator, and there is no proper focus on financial stability. The US will have to decide which of the two pedals they use to slow down. If you reduce the fiscal accelerator, costs will rise in the future as the next round of fiscal policy will be based on physical infrastructure and then on human capital. The cash accelerator does not add anything to economic growth, only to the prices of financial assets. The right thing to do would be to slow down monetary policy, maintain the fiscal accelerator, and increase pressure on rules to ensure financial stability. If this continues, the monetary accelerator will have to abandon the financial accelerator, and this will be tragic for future years of growth.