Count me among those who believe that the latest statement from the Federal Open Market Committee upgraded the outlook for both growth and inflation in the U.S. Yet, what may prove much more significant about the statement lies in what it didn’t cover: namely, Japan.
In its usual concise manner, the FOMC informed us this week that America’s economic recovery “is on a firmer footing” and that inflation is facing “upward pressure.” The hope is that the former will prove durable and that the latter will be transitory though neither are certain.
The statement was silent on the implications for the U.S. of the tragic disasters in Japan, the world’s third-largest economy. I can think of two principal reasons for this.
The FOMC may have lacked the information required to take even a preliminary position. After all, the group met only a few days after the earthquake and tsunami hit Japan. Much of the background material for the meeting was prepared before those awful events. Moreover, uncertainty prevails after such disasters. Indeed, the Japanese authorities themselves don’t yet have a good handle on the extent of the damage, and the continuing instability of several nuclear reactors materially increases the uncertainties.
A second interpretation is that this important policy-making body believes that the economic impact of Japan’s disasters on the U.S. will be transitory. As such, it would be legitimate for policy makers to “look through” the tragedy when assessing the implications for the U.S. economy.
This sanguine view could sound heartless and absurd in light of the horrific images of human suffering and physical damage. Yet it has also been expressed by some economists who have used the 1995 Hanshin (Kobe) earthquake as a valid, legitimate reference.
Through this prism, the aftermath of Japan’s natural disasters will be dominated by large reconstruction spending. Growth resumes in a V-shaped fashion, and the initial (shortage-driven) inflationary spike is normalized as supply chains are restored. As such, it would be imprudent for the FOMC to react to the immediate economic impact of the disasters since it will prove temporary and reversible.
Once rescue operations are complete, Japan will indeed embark on a massive reconstruction program that, I believe, will be successful. Yet there are three reasons why it’s way too early to conclude that the aftermath of these events will have only a transitory impact on the global economy.
First, consider the nature of this terrible shock. In addition to the large wealth destruction and the worrisome health risks of released radioactive material, the spiraling crisis at the Fukushima nuclear reactors raises difficult questions about how and when electricity will be fully restored throughout the country. It will also fuel a global debate about the future of nuclear power, an important source of energy.
Second, think about the funding of Japan’s reconstruction program. The mix, particularly involving debt financing and the repatriation of Japanese savings invested outside the country, will matter quite a bit in terms of the impact on different asset classes. As the Federal Reserve knows well, changes in asset valuations can influence consumer behavior and market volatility.
Third, the Japanese disasters are not happening in isolation. They add to the supply shock that the global economy already faces due to the uprisings in the Middle East and the related increase in oil prices. As such, the risk of a global macro tipping point cannot, and should not, be ignored.
No words can come close to capturing the enormity of the human suffering going on today in Japan. Like many others, my heart goes out to all Japanese, and I still struggle to comprehend the extent of the human devastation, let alone predict its implications for policy making in other countries.
I hope that this is what drove the FOMC’s decision to exclude any reference to Japan in its statement. The alternative of assuming that that U.S. policy should simply “look through” the tragedy would be a mistake.
By Mohamed A. El-Erian
Mohamed A. El-Erian is Pimco’s chief executive officer and co-chief investment officer, and the author of the book “When Markets Collide.” The opinions expressed are his own. ― Ed.