Throughout 2022, Mohamed El-Erian has warned that the likelihood of a U.S. recession is “uncomfortably high.”
But this week, the economist—who serves as president of Queens’ College at the University of Cambridge—said that he fears a recession may now be inevitable if the Federal Reserve wants to reduce inflation to its 2% target.
The Fed has raised interest rates seven times in 2022 hoping to cool the economy and tame inflation that reached a four-decade high in June.
In the beginning of 2022, the central bank’s chairman, Jerome Powell, said that his goal was to ensure a “soft landing” for the U.S. economy—where inflation would come down without a recession—throughout the process.
But Powell’s tone changed in August, when he admitted at an annual symposium in Jackson Hole, Wyo. that some “pain” will be necessary to get inflation under control.
And now, with year-over-year inflation sitting at 7.1% last month, El-Erian believes that consumers may have to rethink what a “soft landing” could entail altogether.
“The best we can hope for is, by the middle of next year, we’ve gotten to stable inflation of about 3% to 4%,” he told MarketPlace on Tuesday. “They keep on telling us that they’re gonna pursue 2% in the future, and society learns to live with a stable inflation rate that is not 2%. That is the new definition of a soft landing, now that we can’t avoid a recession, unfortunately.”
El-Erian said the Fed can get inflation all the way back to 2%, but it will come “at a massive cost to the real economy”—and he believes three to four percent inflation may not be the worst thing.
If the Fed were creating its inflation target today, the economist said he doesn’t believe it would be 2%.
“I think most people agree it would be higher than that,” he noted.
But El-Erian also argued that the Fed can’t increase its inflation target, because it would threaten its credibility with investors. And he isn’t the only one making the case.
Despite a growing chorus of critics who argue for a higher inflation target, Claudia Sahm, the founder of Sahm Consulting and a former Federal Reserve economist, also believes the Fed should maintain its 2% target.
“The Fed is not going to give up on its 2% target, and I think that’s appropriate,” she told Fortune in October. “They accepted that as a target and said that would be a ‘job well done,’ so I think it would be disruptive for them to say: ‘Oh, actually, we’re gonna redefine job well done.’”
Still, the Fed’s 2% inflation target wouldn’t be an issue at all if the Fed hadn’t misjudged inflation in 2021, calling it “transitory,” El-Erian said.
The mistake has forced the central bank to “play catch-up,” putting enormous pressure on the economy.
“Normally, you increase interest rates gradually and in a very measured fashion, because you want to assess the impact on the economy,” he explained. “If you are late—and the Fed has been very late—you have no choice but to move really quickly…The problem with moving so quickly is that you don’t have enough time to assess what the impact on the economy is.”
Still, El-Erian believes the Fed has “no choice but to go after inflation.”
“That is their mandate. Because they’re so late, there will be undue damage to the real economy — to employment, to livelihoods — that could have been avoided,” he said. “Because they’re so late, they’ve lost credibility. And because of that, we risk more financial instability.”
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