By Mohamed El-Erian
NEWPORT BEACH – I don’t know about you, but whenever I am in an airplane experiencing turbulence, I draw comfort from the belief that the pilots sitting behind the cockpit’s closed door know what to do. I would feel very differently if, through an open door, I observed pilots who were frustrated at the poor responsiveness of the plane’s controls, arguing about their next step, and getting no help whatsoever from the operator’s manuals.
So it is unsettling that policymakers in many Western economies today resemble the second group of pilots. This perception reflects not only the contradictory pronouncements and behavior of policymakers, but also the extent to which economic outcomes have consistently fallen short of their expectations.
This perception is evident in Europe, the United States, and Japan, where indicators of economic sentiment are deteriorating again, already-weak recoveries are stalling, and over-stretched balance sheets are becoming even more precarious. Understandably, companies and households are becoming even more cautious – inevitably making a difficult job for policymakers that much harder.
In Europe, policymakers have failed to counter an expanding sovereign-debt crisis in the eurozone’s periphery, despite many summits and programs, multiple expensive bailouts, and the imposition of painful economic sacrifices on societies. Like an airplane piloted in confusion, the European economy has not behaved according to the instructions. As Greek Prime Minister George Papandreou put it last week in his powerful letter to the head of the Eurogroup, Luxembourg’s Prime Minister Jean-Claude Juncker, “The markets and rating agencies have not responded as we had all expected.”
With outcomes that fall far short of policymakers’ projections, it is not surprising that there is little harmony in official circles. Narratives increasingly conflict – and in an astonishingly open and unsettling way.
Disagreement in Europe is not limited to that between “solution providers” (the troika of the European Central Bank, the European Union, and the International Monetary Fund) and countries now implementing painful austerity measures (Greece, Ireland, and Portugal). Damaging discord has emerged within the troika itself, with a particularly disruptive impasse between Frankfurt, where the ECB resides, and Berlin, the seat of the German government.
The situation in the US is not as acute as it is in Europe, but policy impotency prevails here, too. Despite unprecedented fiscal and monetary stimulus, economic growth remains sluggish, and unemployment is stuck at a worrisomely high level. The medium-term fiscal outlook continues to deteriorate while, in the short term, politicians play with the country’s valuable AAA credit rating by arguing like schoolchildren over how to extend the debt ceiling.
Then there are the complex technical difficulties facing policymakers, to which US Federal Reserve Chairman Ben Bernanke referred in his refreshingly candid manner, acknowledging that “We don’t have a precise read.”
The Fed’s economic manuals, including technical models and historical analyses, shed insufficient light on today’s economic situation. Little wonder, then, that the latest release of the closely followed minutes of the Federal Open Market Committee meeting points to a divided body, whose members anticipate divergent paths for monetary policy, with some expecting further accommodation and others expecting a round of tightening.
Meanwhile, Japan continues to languish. Four months after a major earthquake, a devastating tsunami, and the start of persistent nuclear uncertainties, a comprehensive reconstruction program has yet to be launched. The resulting economic uncertainties are compounding years of inadequate growth and deteriorating public-debt dynamics.
Six important issues speak to the problem for policymakers in Europe, the US, and Japan. First, all three economic areas are struggling with unsettling de-leveraging dynamics. Like oxygen being sucked out of our metaphorical airplane in midflight, deleveraging destabilizes societies and undermines the traditional effectiveness of official policies. Indeed, left completely to their own dynamics, these economies would probably shed excessive debt and alter long-standing social contracts in a manner that is both highly disorderly and that leads to economic contraction and a higher risk of another financial crisis.
Second, domestic de-leveraging dynamics are aggravating other structural impediments. While the specifics vary by economic region and sector (housing, labor markets, credit intermediation, etc.), it is a combination with a common and unfortunate outcome: it inhibits economies’ ability to grow, and thus to overcome debt overhangs in an orderly way.
Third, policymakers are operating in a global economy that is in the midst of major re-alignments, as several systemically important emerging economies, led by China, continue to plow through their developmental breakout phase.
Fourth, in choosing cyclical measures to deal with structural problems, policymakers have complicated matters even more – a reflection, again, of their inability to understand the unusual challenges that they face.
Fifth, politics is complicating matters significantly. The reason is simple: in most cases, the required structural measures involve immediate pain for longer-term gain – a tradeoff that politicians abhor, especially when they are subject to short election cycles.
Finally, communication has been dreadful. Rarely have I witnessed such failure by policymakers to provide a clear vision of their medium-term economic vision – a failure that has added to the general and unsettling sense of uncertainty.
All of this speaks to why we should pity today’s policymakers, who must confront unusually difficult challenges with abnormally ineffective tools. But pity is not a free pass: we should also urge policymakers to shift from their traditional cyclical mindset to one that can better comprehend, and effectively address, the more complicated, yet critically important, structural issues that underlie today’s malaise.
Unfortunately, this will not happen overnight; and, in some cases, conditions might have to become a lot worse in order to focus policymakers’ minds. In the meantime, companies and households lucky enough to be in a position to build precautionary cushions will inevitably continue to do so. Others, unfortunately, will be vulnerable to even greater stomach-churning turbulence – without the perceived benefit of a closed cockpit door.