Tags: el-Erian | pimco | central | banks

El-Erian: Don't Overestimate Power of Central Banks

Sunday, 17 Jun 2012 04:20 PM

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Mohamed El-Erian says it's important to distinguish between what central banks can deliver and what they are incapable of doing.

"In the context of today’s complex crisis in Europe, these critical institutions have essentially been reduced to the role of fire brigades," El-Erian, chief executive of Pacific Investment Management Co., writes in the Financial Times.

"They can try to reduce the risk of a fire and, should one occur, stand ready to fight it and contain damage."

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.

"But, acting on their own, they are unable to alter materially the behavior of those who place whole neighborhoods at risk."

Through both emergency liquidity operations and the willingness to stand as a solid counterparty in dysfunctional markets, central banks can offset — but not eradicate — disruptions to the payments and settlement system, El-Erian notes.

Most critically, they can reduce the devastating impact of market “sudden stops,” which are the equivalent of economic and financial heart attacks for capitalism.

“Simply put, if they are not joined by more effective responses on the part of politicians and other government agencies, the best central banks can do is to slow marginally the steadily eroding impact of the West’s triple threat — of too little growth, too much debt and excessive political polarization,” says El-Erian.

“And in pivoting from crisis prevention to crisis management, they can (and are) on alert to clean up the mess, but cannot counter all of the damage.”

The Washington Post reports that the European Central Bank was ready to take action if financial market conditions significantly worsened after Sunday’s vote in Greece.

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.



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