european financial crisis

Bernanke is driving the car but can't see the road

June 28, 2013: 10:26 AM ET

The Federal Reserve appears over-optimistic in its economic forecast.

By Mohamed A. El-Erian

<> on July 18, 2012 in Washington, DC.FORTUNE -- Last week, Fed Chairman Ben Bernanke used a simple car analogy to convey what the central bank may do going forward. Rather than tap the brakes, the Fed would ease a little on the accelerator; and it would do so only if economic conditions strengthened sufficiently.

By distinguishing in this way between the brakes and the accelerator, Bernanke was hoping to convey the Fed's continued, but appropriately adaptable support of the economy. Judging from subsequent analyst commentary, however, the distinction essentially fell on deaf ears. With the resulting market anxiety so pronounced and disorderly, other entral bankers, both in the U.S. and elsewhere, felt compelled to quickly walk back from -- or, more accurately, "talk back" -- what Bernanke had said.

The revised narrative of the last few days stressed that investors and analysts had misinterpreted Bernanke. We were repeatedly told that the possibility of easing on the accelerator was just one of many policy alternatives. Some central bankers went further, stressing that the time was not right for any tapering of Fed support. Following such "clarifications," a sense of temporary calm returned to global financial markets.

Going beyond all the conflicting talk from central banks, it is important to note that the disorderly initial reactions to Bernanke's remarks were not due to a failure by the outside world to distinguish between the brakes and the accelerator. It seems that a large part of the communication failure has to do with differing views about the road that the car is traveling on.

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The Fed projects a road that is getting smoother and easier to navigate. Consequently, it forecasts a steady increase in economic growth, declining unemployment, and Goldilocks inflation (as in not too hot, not too cold).

The Fed acknowledges but essentially dismisses the disruptive headwinds that can come from elsewhere. And this leads to a destination that all of us have long hoped for: America's return not just to economic growth and financial stability, but also for this to be associated with the levels of jobs, earnings, and opportunities of the good old days.

Now for the bad news: The Fed's forecasts appear over-optimistic to quite a few of us. Indeed, since the 2008 global financial crisis, the central bank's projections have consistently disappointed, with outcomes falling far short of forecasts.

It is hard to feel comfortable about the accuracy of the Fed's optimistic outlook, particularly if you are worried about insufficient aggregate demand, inadequate supply responsiveness, the detrimental effect of excessive debt overhangs or (like me) some combination of all three.

It is hard to dismiss the potential political potholes along the road created by our highly-polarized Congress, its consistent failure to iterate to comprehensive policy responses, and the occasional inclination for self-inflicted wounds.

It is hard to discount the potential headwinds from Europe. Not only is the eurozone in recession but a growing number of countries, led by Cyprus and Greece, lack any meaningful growth engines. It is just a matter of time before debt restructuring and exit concerns resurface in these countries.

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It is hard to disregard the challenges that emerging economies are having navigating this enormously fluid and unusual global economy. Whether it is the increasing policy incoherence of Brazil or pockets of excesses in China, this important block of countries is no longer the reliable engine of growth for the global economy.

Then there are the genuinely much more complex -- and hotly debated -- structural and secular questions. They have to do with the changing nature of productivity gains, the distributional impact of meaningful innovations, and evolving social trends.

In sum, the question is not whether the U.S. economy will continue to heal after the trauma of the global financial system. It certainly will, and will do so in a much more impressive manner than Europe. The question is whether this healing is enough in current conditions to decisively overcome other challenging issues, thus returning the economy back to where everyone wishes to see it.

All of which takes us back to the Fed.

Perhaps Bernanke and his colleagues are not really all that confident about the economic outlook, including the external context. Perhaps what motivated the remarks on the potential tapering of artificial Fed monetary support is also linked to the recognition that the accelerator they are using could over-stress certain parts of the engine, thus threatening to cause serious collateral damage in the future (or what Bernanke once characterized as "costs and risks").

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In a less imperfect world, Fed tapering would indeed occur at some stage but for the right reasons: Because politicians (and Congress in particular) are finally stepping up to their policymaking responsibilities and taking comprehensive steps to ensure high and inclusive growth and job creation. This would do more than reduce the risk of blowing a gasket while maintaining a well-running car; it would also assist in overcoming nasty headwinds.

Only in those circumstances would markets interpret (and welcome) Fed tapering as an indication of improvements in both the car and the road. In the meantime, remarks about easing on the accelerator or tapping the brakes would likely cause additional bouts of market anxiety, no matter how justified and needed such policy tweaks are from a longer-term perspective.

Mohamed A. El-Erian is the CEO and co-chief investment officer of PIMCO.

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