Pimco's El-Erian: Fed should have tapered (a little)

Mohamed El-Erian, CEO and co-CIO at Pimco, tells FinanceAsia that the Fed should have put a modest tapering programme on the table this month.
Mohamed El-Erian, Pimco
Mohamed El-Erian, Pimco

Mohamed El-Erian, chief executive and co-chief investment officer of Pimco, which has $1.97 trillion of assets under management, will appear in FinanceAsia magazine's October magazine. Here we give a taste of what he had to say in this exclusive interview. 

FinanceAsia: Was the US Federal Reserve right to delay the taper in September?
Mohamed El-Erian: “The decision [to delay tapering Fed asset purchases] is indicative of how hard it is to make monetary policy with so much uncertainty and the changing of the leadership there. If I had been in [Ben] Bernanke’s shoes with the information that Pimco has – and understanding that the Fed has superior information than we do – I would have argued for ending $10 billion worth of monthly asset purchases.

Currently the Fed is buying $45 billion worth of Treasuries and $40 billion worth of mortgage-backed securities. I would have focused the tapering on the Treasuries. This is not because the Fed has achieved its economic objectives, because it hasn’t. This would have been to avoid collateral damage to the economy of prolonged reliance upon quantitative easing. A modest taper of Treasuries buying would have allowed the Fed to walk through a door that was wide open in terms of market expectations.” 

Does forward guidance work?
“We don’t know yet. Central banks have three tools. First is flooring interest rates, but that option is completely exhausted in the US, in the UK, in Japan and almost exhausted in the eurozone. The second tool is direct asset purchases, but there is a limit to how long they can do that.

As Bernanke recognised in August 2010, the longer we rely on quantitive easing, the greater the risk that the benefits are outweighed by the costs and risks. QE encourages excessive risk taking because buyers of financial assets become insensitive to price, so we get resource misallocation and it interferes with the normal functioning of markets, particularly with respect to liquidity.

The third tool, the only left to central banks now, is forward guidance, because their economies are not yet strong enough to reach escape velocity from recession. I see no choice for central banks but to use forward guidance even more aggressively – but this strategy is already stretching credibility.”

So long as QE is maintained, it seems to me unlikely that economies can reach escape velocity. To do so requires the revival of animal spirits but QE seems to be stifling companies’ risk appetite.
“The QE bet is a simple one: by artificially lifting asset prices, central banks trigger the wealth effect and those animal spirits. This in turn will boost sluggish fundamentals.

It’s very imperfect. It would be better to improve the competitiveness of our economy, sharpen our resource allocation and get rid of structural impediments. But the politics in the US mean these things are sidelined; politicians can’t agree on difficult choices and have therefore handed off the responsibility of economic governance to the Fed.

So you are right: financial markets have reacted to QE but the real economy isn’t buying it. Companies want to see a genuine boost to the economy, not an artificial one. If the Fed maintains QE long enough, it should allow balance sheets to heal, which will energise households and companies. But it’s not a costless exercise.”

For the complete interview, see FinanceAsia's upcoming October magazine edition.

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