The Fed could have to quietly abandon its goal of getting inflation down to 2% next year, Mohamed El-Erian says
- The Federal Reserve may have to cast aside its 2% inflation target in 2023, according to Mohamed El-Erian.
- Inflation has cooled from four-decade highs but still ran at an elevated 7.7% in October.
The Federal Reserve may have to abandon its inflation target next year as it falls behind in its fight against inflation because of past policy mistakes, Mohamed El-Erian has warned.
The top economist said Monday that he expects the Fed to officially stick to its 2% goal for consumer-price increases — but quietly pursue a higher one so it can avoid crushing the labor market by carrying on with its aggressive monetary tightening campaign.
"Signaling the pursuit of an objective while quietly heading in a different direction is a tactic in politics that is as old as it gets," El-Erian wrote in a Financial Times op-ed. "Now the US Federal Reserve may be forced to consider such a tricky maneuver as 2023 unfolds."
"It could prove tempting for the Fed to continue to signal a 2% inflation target but, in practice, end up pursuing a higher one hoping that the public will accept it over time as indeed a superior and stable objective," he added.
The Fed officially adopted its 2% inflation target in 2012. It forms part of the central bank's dual mandate, which requires it to pursue "maximum employment and price stability".
The central bank has raised interest rates by 375 basis points in 2022 in a bid to tame inflation that's still running well above the official target, after scaling four-decade highs earlier this year.
The rate increases haven't seemed to affect the red-hot labor market yet, with November's non-farm payrolls report showing that the US economy added 263,000 jobs.
But the Fed might end up quietly accepting an inflation target of between 3% and 4% to ensure it doesn't have to plunge the economy into a recession to achieve its goal, according to El-Erian.
"The world's most powerful central bank is now confronted with two unpleasant choices next year: crush growth and jobs to get to its 2 per cent target or publicly validate a higher inflation target and risk a new round of destabilized inflationary expectations," he said.
El-Erian has repeatedly criticized the Fed's monetary policies from last year — when it maintained low interest rates and insisted that inflation would be "transitory".
The central bank's insistence last year that the inflation spike would prove temporary is why it may have to abandon its 2% target next year even though consumer prices have recently shown signs of cooling, he warned.
"The Fed may end up seeing it as better than the other main options, now that it has fallen well behind an inflation process that is likely to prove stickier than many currently expect, including the central bank," El-Erian said.
"Unfortunately for all of us, its road from here does not get much easier any time soon despite the fall in inflation," he added.