Today's Global Rubik's Cube of Frustration.

Author:El-Erian, Mohamed A.
Position:AN EXCLUSIVE INTERVIEW - Interview
 
FREE EXCERPT

David Smick: What is the state of the world economy? It's as if we are experiencing a giant global economic Rubik's Cube of frustration.

Mohamed El-Erian: While the consensus baseline for the global economy points to a synchronized pick up in growth, albeit a still-muted one, it is subject not just to uncertainty but, to use former Fed Chairman Ben Bernanke's phrase, "unusual uncertainty" on account of four economic issues. And all this is before we consider geo-political risks and rather fluid domestic and, in the case of Europe, regional political landscapes.

The first economic uncertainty is the consistently sluggish behavior of productivity. The second is the persistence of "lowflation," despite a sharp fall in unemployment and years of ultra-loose monetary policy; or what current Fed Chair Janet Yellen has called the inflation "mystery." The third is weak wage dynamics, again despite significant employment gains--we recently saw an historically unusual call by European Central Bank President Mario Draghi on the German unions to step up their wage demands.

And then there's the fourth element which relates to what I call the global adding-up challenges--from virtually no country willing to live with a stronger currency to simmering protectionist threats and weak global policy coordination that no longer shares a common vision and a common objective. There is also the question of how the global economy would handle the eventuality of more than one systemically important central bank trying to normalize its monetary policy after many years of reliance on unconventional measures. It seems that one bank, the U.S. Federal Reserve, is able to deliver, borrowing a concept investor Ray Dalio used in another context, a "beautiful normalization." It is not clear what happens when several try to do so.

Smick: In the past, some industrialized economy somewhere was always willing to accept a strong currency. That appears to be changing.

El-Erian: Correct. Nowadays, the currency market has what I think of as "hot potato syndrome"--that is, virtually no one seems willing and able to live with a sustainably stronger exchange rate. This is not only due to the rather weak growth fundamentals that persist in the advanced economies and that have aggravated the inequality trifecta--of income, of wealth, and of opportunities. In addition, technological innovation, spearheaded by the increasingly powerful combination of artificial intelligence, big data, and mobility, is changing not just what we do, but also how we do things. On top of that, we have protracted policy over-reliance on central banks as the only game in town in terms of delivering macroeconomic outcomes.

Smick: Central bankers have completely ignored the fiscal side. They have let the governments off the hook.

El-Erian: And it appears that the politicians may have gotten too comfortable letting the central banks carry too much of the policy burden. This is a challenging time for central banking, whose policy tools are stretched while several systemically important institutions are subject to greater political scrutiny. In such a world, central bankers have two choices when it comes to basic policy orientation.

The first is to become highly data-dependent, retain maximum policy optionality, and keep waiting for the high-frequency data before making decisions; all this while also seeking to continue to suppress financial volatility, boost asset prices, and minimize any market disruptions. The second choice is to decide to develop a more definitive and confident vision as to where all this is going, then try and shape more actively the journey to a better destination.

Central bankers in the advanced economies are mostly in the first camp right now because they have a strong sense that the destination is not theirs to deliver. Rather, high and inclusive growth requires the deployment of additional tools relating both to supply responsiveness and demand management that central banks simply do not possess. In the process, we end up with rather short-term policymaking and a potentially unhealthy co-dependence between central banks and financial markets.

It is important to remember that this is not the fault of central banks. Indeed, if it weren't for their bold policy actions, the world would have fallen into a multi-year economic depression in 2008-2009 and, in the case of Europe, the eurozone would have collapsed shortly thereafter. Rather, it reflects continued delays in a much-needed policy handoff--from excessive reliance on central banks to a more comprehensive policy response.

Smick: I never would have imagined we'd see the political community more hawkish than the central bankers.

El-Erian: When Chairman Bernanke in August 2010 signaled that the Fed would use unconventional measures not to normalize financial markets as the central bank did very well in 2008-2009, but to pursue much broader macroeconomic objectives, he specified the policy equation in terms of "benefits, costs, and risks."

The longer unconventional monetary policy has used the asset markets and financial valuations to try to deliver better economic outcomes, the lower the benefits have been, and the higher the costs and the risks, including political ones.

No one envisaged that the U.S. Federal Reserve would remain in this policy mode for so long--over-relying, along with the ECB and the Bank of Japan, on an inherently narrow policy response. Remember, central banks cannot promote productivity-enhancing infrastructure. They cannot remove the anti-growth biases in tax systems. They don't have the means to improve the functioning of the labor market, pursue education reform, or enhance skill acquisition. And...

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