Political dysfunction in Congress has given the Federal Reserve Board an outsize role in managing the economy, leaving many fundamental problems unaddressed, according to market experts.
“We have too much monetary policy,” Sheila Bair, former chairwoman of the Federal Deposit Insurance Corp., told an audience at the National Press Club in Washington today. “We really don't have any fiscal policy.”
With lawmakers on Capitol Hill bogged down in partisan fights on most issues, the burden has fallen on the Fed to generate economic growth. But the central bank can only set interest rates.
“The Fed can only act with indirect policy,” said Mohamed El-Erian, chief executive and co-chief investment officer of the bond giant Pacific Investment Management Co. LLC, who participated on the panel. “It cannot invest in infrastructure. It cannot change the tax code.”
What it has resorted to — monthly $85 billion bond purchases designed to keep interest rates low — is a policy that comes with much risk.
“We are in a period where the Fed, not by choice but by necessity, is using experimental policies that haven't been tested,” Mr. El-Erian said. “It's like a doctor that gives you medicine — because he or she had to do it — that has not been clinically tested. That's why the notion of side effects is so important.”
Inexpensive money, however, will not be central to determining whether the U.S. can accelerate its tepid economic growth, Mr. El-Erian said. Instead, the focus should be on making structural reforms, increasing aggregate demand, lowering debt levels and improving education, labor and training policies.
“One of the problems about the Fed being the center of attention is it diverts discussion away from those other things,” Mr. El-Erian said.
The financial markets are obsessed with figuring out when the central bank will begin the so-called tapering of the bond-buying program.
John Taylor, a professor of economics at Stanford University and senior fellow at the Hoover Institution, told the National Press Club audience that that the Fed should start tapering in September and “lay out a strategy to get back to normal policy.”
Mr. El-Erian warned that it will “take a long time to get back to normal” and that tapering could be painful.
“Asset prices will come down to reflect the fundamentals,” Mr. El-Erian said. “And when that happens, unfortunately, that becomes a drag on the economy. And that's the thing we worry about most.”
During the transition, Congress likely will remain on the sidelines. There's little optimism that it will suddenly become productive in September following its summer recess, when it begins wrestling with the federal budget and the debt ceiling.
Mr. El-Erian said that re-election pressures, especially from extreme elements of their own parties, force legislators to take strident positions that make it almost impossible to reach agreements on difficult issues, such as tax reform, that could boost the economy.
“That's why good proposals are not discussed on the basis of merit,” Mr. El-Erian said.