El-Erian at the Fed?

The Wall Street Journal has a new piece discussing rumors that Mohamed El-Erian might be chosen for the position of vice chair of the Board of Governors:

In recent years, Mr. El-Erian has voiced somewhat hawkish critiques of the Fed’s policy stance, including decisions to hold interest rates at ultralow levels despite signaling plans to raise them. In recent months, he has suggested that the Fed’s inflation target of 2% might be too high given structural forces holding down consumer prices.

A few comments:

1.  We now know that those who offered hawkish critiques of Fed policy a few years ago were wrong.  Inflation has continued to undershoot the Fed’s target.

2.  When “structural forces” hold down inflation, they do so by boosting RGDP growth.  There is no other way by which structural forces can hold down (GDP deflator) inflation.  None.  RGDP growth has actually been at unusually low levels over the past decade.  Thus we now know that structural forces are not holding down inflation.  It was slow NGDP growth.  Those who think otherwise are confusing microeconomic factors (Amazon, China, etc.) with macroeconomic factors.  Yes, Amazon and China hold down specific prices, but only by boosting GDP growth.  And this mistake cannot be excused by pointing to mismeasurement of inflation.  Maybe tech is causing actual inflation to be lower than measured inflation, but the puzzle being discussed is why measured inflation is so low.

Confusion over these sorts of basic macro issues is exactly why we need to appoint world class experts on monetary economics to the Fed.  People like El-Erian tend to assume that a tighter monetary policy would allow the Fed to have a higher path of interest rates going forward.  In truth a tighter monetary policy would result in slower growth and a lower path of the natural rate of interest over time.  (See Trichet, ECB.)  If the Fed didn’t realize this and persevered with their plan to raise rates, they would create a depression.  I’m not predicting a depression because I don’t expect the Fed to do this, just pointing to the logical consequence of this sort of mistaken reasoning.

Higher interest rates should not be a goal of monetary policy, but if it is a goal then you get there by making monetary policy more expansionary, and boosting the trend rate of NGDP growth.

PS.  I have a cameo role in a new MRU video.

PPS.  I was interviewed for this piece in the Commercial Observer.

HT:  Patrick Horan, Vaidas Urba



27 Responses to “El-Erian at the Fed?”

  1. Gravatar of foosion foosion
    15. November 2017 at 08:32

    Is it a silver lining that appointing incompetent hawks to the Fed will hurt the economy in the short run, thereby decreasing the chances of Trump and other Republicans getting re-elected?

  2. Gravatar of ssumner ssumner
    15. November 2017 at 08:47

    foosion, Not really. Recessions can lead to protectionism, bailouts, etc.

  3. Gravatar of Becky Hargrove Becky Hargrove
    15. November 2017 at 09:02

    Your second point is incredibly important – it can’t be stressed enough.

  4. Gravatar of bill bill
    15. November 2017 at 09:14

    In a perverse way, El-Erian’s success proves EMH.

  5. Gravatar of sean sean
    15. November 2017 at 11:03

    I had a friend ask me this question yesterday. My quick response was El-Erian would be awful (mostly for the reasons you cite).

    The one caveat I will add; El-Erian is a market commentator. To some extent you always have to preface anything a person says public with the role they play in life. Investors (mostly mistakenly) want their pundits/asset managements to talk about risks. It makes El-Erian seem wise and thoughtful and prudent with investments. A guy you would want to give your money too.

    Point being his internal mental models may be much different than his external models where he is basically a salesman for whichever fund he’s working for at the time.

    I would pass on him, but he does seem to be a smart guy so maybe his private thoughts are much different…and he realizes the obvious a central bank with a printing press controls inflation/deflation.

    PS. If I were up for the fed would you back me.

  6. Gravatar of bill bill
    15. November 2017 at 13:03

    What should we think about a Fed candidate who says things like this:

    The Fed needed the authority to solve an increasingly serious problem in the Fall of 2008: the risk that the Fed’s emergency lending, which had the side effect of increasing bank reserves, would lead short-term interest rates to fall below the federal funds target and thereby cause the Fed to lose control of monetary policy. The Fed had been selling Treasury securities it owned to offset the effect of its lending on reserves (sterilization). But as its lending increased, that stopgap response would at some point no longer be possible because the Fed would run out of Treasuries to sell. At that point, the Fed would be forced to either limit the size of its interventions, which could lead to further loss of confidence in the financial system, or lose the ability to control the federal funds rate, the main instrument of monetary policy. The ability to pay interest on reserves, would help solve this problem. So, by setting the interest rate it paid on reserves high enough, the Fed could prevent the federal funds rate from falling too low, no matter how much lending it did.

  7. Gravatar of Larry Larry
    15. November 2017 at 14:27

    “Inflation has continued to undershoot the Fed’s target”

    I am sure that is true using statistics provided by the Fed. I don’t doubt that for a moment. Yet, my day to day experiences cast doubt.

    10 years ago if my wife and I went out to dinner it would cost us $40-$50. Today, if we go out to the same restaurant it will cost $80. That’s a much bigger increase than 2% compounded.

    11 years ago I bought a two year old Mazda pickup truck. I paid 13K for it. If I were to replace it today it would cost over 20K and I wouldn’t get as capable a vehicle.

    10 years ago we would go out to a live music show and it would cost us $40. Now it will cost us double that.

    Even the cost of groceries has risen significantly. I don’t remember what they cost 10 years ago but I know they cost significantly more than they did then.

  8. Gravatar of Major.Freedom Major.Freedom
    15. November 2017 at 17:37

    “When “structural forces” hold down inflation, they do so by boosting RGDP growth.”

    No they don’t, and anyone who has even a basic understanding of the concept of the demand for money holding, as well as fiduciary credit and concomitant money supply contraction, as well as the fact that money is spent on more than just final goods (hint, inflation does not affect the prices of everything equally), would understand.


  9. Gravatar of Major.Freedom Major.Freedom
    15. November 2017 at 17:38

    Price inflation is and always has been underreported.

  10. Gravatar of Major.Freedom Major.Freedom
    15. November 2017 at 18:07

    “There is no other way by which structural forces can hold down (GDP deflator) inflation. None.”

    YES THERE IS. You clearly don’t understand the theory.

    The same structural forces (don’t think of these exclusively as “real” forces, they are “calculative” forces that have as ONE aspect to it, the allocation of real resources) that affect capital ALSO affects the structure of monetary phenomena.

    The “real” structural forces are but one manifestation of that which also affects monetary forces EXTERNAL TO THE CENTRAL BANK (this does not necessarily mean totally independent). You need to also include monetary forces that are brought about, and not only that, but you have to understand monetary phenomena as structured as well.

    Your theory has you seeing but one giant blob of money as if being poured out of a helicopter with the internal STRUCTURE of the real economy being completely independent of the structure of monetary events.

    The structure of central banking, exactly how new money is created, what form it takes, who spends it, on what, and very importantly WHEN, all this very much and to a significant degree affects the structure of real production. Yes the centralized counterfeiter can by way of pressing CTRL-P over and over again make ANY singular statistic rise at a predetermined rate. The Fed could start to target the price of copper. But should it do that, IT DOES NOT MEAN THE PRICE OF COPPER MAGICALLY BECOMES THE ONLY DRIVING VARIABLE OF REAL PRODUCTION. We’d have to look at exactly how the price of copper is being targeted, where money is created, how much, who receives it, what they spend that money on, what happens to interest rates, what happens to where money is spent, etc.

  11. Gravatar of Major.Freedom Major.Freedom
    15. November 2017 at 18:32

    “RGDP growth has actually been at unusually low levels over the past decade. Thus we now know that structural forces are not holding down inflation.”

    That is a false inference. Structural forces can and do keep real production AND money spending down.

    You need to understand that when there is a general desire to hold more money, it is not because they ONLY want to hold more money.
    This is a means to an end. What people want is more stored purchasing power. Well, that can be achieved in a free market, where prices are free to fall to that which will achieve the desired level of stored purchasing power. But with a criminal counterfeiting syndicate, which this blog endlessly seeks to help, prices do not fall. And to all those who foolishly believe that counterfeiting more money can solve the problem of people wanting to hold more money, while spending and prices remain unaffected, you need to get your heads examined for trauma, because MORE money CANNOT get into everyone’s pockets UNLESS prices rise which generates the additional income necessary for people to then hold more money. No, as much as you want to believe, the counterfeiters do not drop new dollars directly into your bank account. You get more money by way of you FIRST earning more money, which means someone else had to have exchanged for that additional money prior to you, and someone else prior to that someone else, and so on.

    While silly mathematical models would have the above process “stablize”, as if the only thing that matters is the subsequent increased general height of the river that everyone drinks out of at the same time, it does not stabilize because of that concept which pulls the rug out from under market monetarism: time.

    It takes time for money to be counterfeited, then some time later initially spent and/or loaned, then sometime later spent and/or loaned again, and so on and so forth. Understanding process is absolutely crucial. For guess what? Individuals put varying, scientifically unpredictable but very much purposeful and meaningful valuations on WHEN a gain will occur. This is absolutely crucial to understanding how inflation affects the structure of (real) production, and not only that, but also to understanding how problems in the structure of real production created by (money supply) inflation, cannot be solved by more of the same.

  12. Gravatar of Benjamin Cole Benjamin Cole
    15. November 2017 at 19:25

    Perhaps we need sociopathologists to explain the “tight money” crowd, not macroeconomists.

    About Mohamed El-Erian I would ask:

    1. Was El-Erian just “talking his book” before? That is, as a money manager at PIMCO he sat on a large bond portfolio. Tighter money would lower long-term interest rates, raising the value of his portfolio in the next quarter to two. He gets a bigger paycheck.

    2. El-Erian before was just pandering to his base, that is his customers, who endlessly jibber-jabber about tight money, as they conflate “loose money” with “financing federal deficits” and federal social welfare etc. Broadly speaking, right-wingers genuflect to “tight money” totems, so El-Erian was just dog-whistling. Loose money is for flabby liberals and Keynesian losers.

    3. El-Erian earnestly believes money should be even tighter, despite PCE core at 1.3% and despite CPI core sans housing at 0.7% (see Kevin Erdmann everyone). Then, El-Erian must believe 0% inflation (as measured) is the optimum rate of inflation that will boost real economic output. There are those, such as Charles Plosser and sometimes John Cochrane, who even posit minor deflation would be best, despite a total lack of recent empirical evidence for this faith.

    Indeed, from 1982 through 2007, the average on the CPI was near 3% and real GDP growth was near 3%. Call it “3+3”. That was recent history in the real world, not a theory.

    We seem to be “2+2” now. Is this better? I would ask Mohamed El-Erian that.

    Unfortunately, macroeconomics has become politics in drag, and monetarism a perverted corner of that, darkened by nostrums, totems, shamans and vulgar self-interest.

  13. Gravatar of Benjamin Cole Benjamin Cole
    15. November 2017 at 20:02

    OT but another take on trade deficits:


    I wish it was someone else other than Paul Krugman making this aberration, as the mere name “Krugman” results in polarized responses.

    But Krugman raises interesting questions about who gains income when large trade deficits are the norm. Sure, you get capital inflows, but Krugman points out the foreigners are not handing money over to be nice. They want a return, and to extract income from the US.

    For example, I would not invest in a Brazil restaurant unless I thought I could ultimately extract more income out than I put in.

    And when the income is extracted, guess what? You Americans have less of it.

    Krugman’s forte is trade, btw.

  14. Gravatar of Matthew Waters Matthew Waters
    16. November 2017 at 13:00


    Those are anecdotes of small expenses (eating at a nice restaurant or live music) and one big expense, but without any quality adjustments.

    A lot of other anecdotes go against the narrative. Gas prices in Nov. 2007 were $2.79. Today it is $2.48. A gallon of milk has gone from $3.80 to $3.10. A dozen eggs from $1.77 to $1.50.


    When these items increased in prices, it registered as “the ivory tower economists in the BLS don’t go to the grocery store.” But when volatile things like food and energy decline, the decline isn’t registered.

    Inflation is really hard to measure, especially quality adjustments. But if the “true” inflation rate since 2007 was 4%, then the *average* price would have gone up 48% (1.04^10 – 1).

    Rent (or imputed rent) is by far the biggest expense and has averaged 1%, or up 10%. Inflation data does not looking at house prices, which is an investment price, but rather the equivalent rents. So rents and imputed rent actually went up in 2007, unaffected by housing price collapse.


    High inflation areas such as health care offset against food, energy, electronics, clothing and other low inflation areas. It’s tough to get to 48% inflation with, well, only health care against all other consumption baskets. And quality adjustment is a big part of health care. A new drug or device that costs 10x more isn’t 900% inflation. It’s a completely new product, like the iPhone in 2007.

  15. Gravatar of Matthew Waters Matthew Waters
    16. November 2017 at 13:31

    I think El-Erian falls into the Upton Sinclair trap: “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”

    Yes, it’s a quote that Krugman uses a lot, but it in applies in spades to financial market practitioners. Another historic quote that comes to mind is Mellon’s (maybe apocryphal) quote during the Depression: “Liquidate labor. Liquidate stocks. Liquidate farmers. Liquidate real estate.”

    Strangely, it’s not clear that VSP’s actually do better off financially with tight money. But in the financial industry and with large investors, most at least *believe* tight money definitely helps their savings. Looser money is considered a transfer from hard workers who saved their money to free-loaders. This narrative goes back to bimetallism debates in 1900 and certainly even before that.

    The narrative is strong enough for El-Erian and most other financial people to believe it. In practice, VSP’s in the financial sector would never agree that higher interest rates only happen with more inflation.

  16. Gravatar of Benjamin Cole Benjamin Cole
    16. November 2017 at 18:54

    Well, take good news where you can get it:


    “Strategies that central banks should consider including not only the bond-buying and forward guidance used widely in the last recession, but also negative interest rates that was used in some non-U.S. countries, as well as untried tools including so-called price-level targeting or nominal-income targeting. Central banks may also want to consider setting a higher inflation target, he said.”


    Yes, a nod to NGDPLT, only a decide or so after Scott Sumner and Marcus Nunes popularized the idea.

    Well, I say do monetary stimulus the aboveboard way and go to helicopter drops, but maybe that is too easy, effective and democratic.

    The Rube Goldberg-approach, with reverse repos, and and buying MBS, and accordion-like Fed balance sheets is much preferable, no?

  17. Gravatar of vak vak
    17. November 2017 at 06:27

    Dear Prof. Sumner,

    Thank you for your way of explaining monetary policy. I long time ago I took some econ classes in college and I really enjoy the way some of your posts hold the reader’s hand while encouraging s/he to think from first principles.

  18. Gravatar of Lorenzo from Oz Lorenzo from Oz
    17. November 2017 at 11:19

    This piece might amuse you.

    The author, Jeffrey Snider, is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. He is of the view that central bankers should pay more attention to information from markets.

  19. Gravatar of Benjamin Cole Benjamin Cole
    19. November 2017 at 03:48

    As I am banned (I guess permanently) from Econlog, here is a comment Scott Sumner’s recent post “The Third Option.”

    A good post but you somewhat mix-up property development, zoning and monetary policy when you discuss Japan and housing costs, and miss a chance to illuminate rising US housing costs and inflation.

    Monetary policy is a sideshow!

    Tokyo had 142,417 housing starts in 2014 and population of about 9.2 million, compared to 18,200 housing starts in Los Angeles County, and a population of about 10.2 million. This is typical of the last 20-30 years in both regions.

    Imagine that year after year. Duh, what do you think is going to happen?

    As George Selgin has pointed out, you can get measured inflation if you constrain supply, such as a corn bust in an agricultural economy. The wrong approach is to tighten after a corn bust, and also it is limiting to think monetary policy is the prime cause of inflation following a corn bust.

    Or to presume monetary policy is the prime cause of measured inflation in the US, with our noose around new housing supply. Kevin Erdmann tracks CPI-core sans housing. It is at 0.7%

    Also, Japan runs current account trade surpluses. Nations that run current account trade deficits tend to have capital inflows that seek out real estate, including housing. If the supply of housing is limited….

    Market monetarism may become the dominant monetary movement in 10 or 20 years, and I hope so.

    Unfortunately, you may still get declining living standards and soaring housing costs in the US and other nations, even if you follow MM.

    Tight zoning and trade deficits will see to that.

  20. Gravatar of Benjamin Cole Benjamin Cole
    19. November 2017 at 04:13


    some pointers on why housing construction, more than monetary policy, is key to housing costs in Tokyo….

  21. Gravatar of Christian List Christian List
    19. November 2017 at 16:25

    OT: Dispelling misconceptions about what’s driving income inequality in the U.S.

    “A new book, “The Captured Economy” by Brink Lindsey and Steven Teles, argues that regressive regulations — laws that benefit the rich — are a primary cause of the extraordinary income gains among elite professionals and financial managers in the United States and of a reduction in growth.

    This year, the Brookings Institution’s Richard Reeves wrote a book about how people in the upper middle class have shaped both legal and cultural norms to their advantage. From different perspectives, Joseph Stiglitz, Robert Reich and Luigi Zingales have also written extensively about how the political power of elites has undermined markets.

    Problems cited by these analysts include subsidies for the financial sector’s risk-taking; overprotection of software and pharmaceutical patents; the escalation of land-use controls that drive up rents in desirable metropolitan areas; favoritism toward market incumbents via state occupational licensing regulations (for example, associations representing lawyers, doctors and dentists that block efforts allowing paraprofessionals to provide routine services at a lower price without their supervision).”


  22. Gravatar of Benjamin Cole Benjamin Cole
    20. November 2017 at 02:45

    From Bloomberg:

    “Even before Leonardo da Vinci’s Salvator Mundi went to auction Wednesday night at Christie’s in New York, naysayers from around the art world were savaging its authenticity. Various advisers were muttering darkly, both online and in the auction previews. A day before the sale, New York magazine’s Jerry Saltz wrote that though he’s “no art historian or any kind of expert in old masters,” just “one look at this painting tells me it’s no Leonardo.”

    And that was before the painting obliterated every previous auction record, selling, with premium, for $450 million.”

    I hereby suggest art fraud, or at least art authentication for a price, to young scholars.

    Can there be bubbles? I say yes, in collectibles, Franklin Mint items, gold, and art.

  23. Gravatar of Major.Freedom Major.Freedom
    20. November 2017 at 04:50

    What do you call those who apologize for communist money existing in the first place and pretend evil only starts when the communist counterfeiters don’t hit CTRL-P fast enough?

    Hypocritical sociopaths?

    Non-self-reflecting sociopaths?

    Hmm, maybe Cole can explain the goodness of the naked aggression backing all central banks. Totally not sociopathic! Every country has people doing this! It has to be moral and good if it happens like this. Cole can add pedophilia and human trafficking to his growing list of “not sociopathic because there are many elite doing it, you are a sociopath for complaining about it and upsetting the balance”.

    What misguided fools on this blog.


    In other news, CEI is reporting that federal regulations are down 32% since Jan 1, 2017.


    This has been a faster deregulatory administration than Reagan.

    I will rewrite: Trump is the most deregulatory President in US history.

    But he used two scoops and drinks water funny and did what Abe did with feeding the Koi fish.

    Sumner the “libertarian” will remain out of touch and confused at what is happening around him.

  24. Gravatar of Major.Freedom Major.Freedom
    20. November 2017 at 04:54

    I said many years ago this blog is a left wing socialist blog that doesn’t actually value individual liberty.

    Very little if any blog posts of how the Democrats messed this or that up.

    I remain correct in my assessment.

  25. Gravatar of Carl Carl
    20. November 2017 at 12:08

    Major Freedom:

    If you’re going to spend 90% of your waking hours trolling a man’s blog, I would think you’d have the decency to spend 15 minutes actually trying to understand that man’s position. In all your paranoiac reading of this site, you seem to have forgotten to read his post where he lays out his positions on the matter of private vs government control of the mediums of account and exchange: http://www.themoneyillusion.com/?p=23004. I noticed that you didn’t make any comments on that post. I suggest you read it and then if you can actually answer any of the questions raised with something other than your ahistorical praxeological proofs, someone might be willing to listen to you.

  26. Gravatar of Mark Mark
    20. November 2017 at 16:11

    “Krugman’s specialty is trade.”
    Luc Montagnier’s specialty is medical physiology; and yet, he avidly defends homeopathy. Like him, Krugman has only discredited himself by lending his (formerly good) name to running interference for discredited protectionist ideas.

    Montagnier and Krugman both demonstrate one can win a Nobel prize in a field and still hold asinine views within that field.

  27. Gravatar of Benjamin Cole Benjamin Cole
    20. November 2017 at 19:31


    I have always been skeptical of homeopathy, though I am rank amateur in all matters medicine.

    But this article suggests there may be times when homeopathy has a place.


    “Most clinical research conducted on homeopathic medicines that has been published in peer-review journals have shown positive clinical results,(3, 4) especially in the treatment of respiratory allergies (5, 6), influenza, (7) fibromyalgia, (8, 9) rheumatoid arthritis, (10) childhood diarrhea, (11) post-surgical abdominal surgery recovery, (12) attention deficit disorder, (13) and reduction in the side effects of conventional cancer treatments. (14) In addition to clinical trials, several hundred basic science studies have confirmed the biological activity of homeopathic medicines. One type of basic science trials, called in vitro studies, found 67 experiments (1/3 of them replications) and nearly 3/4 of all replications were positive. (15, 16}.


    But back to Krugman. He seems to have some good points about chronic current account trade deficits, especially in light of a central bank that evinces a squeamish hysteria about “tight labor markets.”

    Krugman does not address the issues of heavy foreign capital flows into restricted markets, such as property-zoned housing.

    But add it up: A US central bank that will not conduct monetary offset, yet huge trade deficits and huge capital flows into restricted housing markets. Less demand for labor and more-expensive housing.

    Seems to me Krugman is onto something.

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