The boost to global risk sentiment following bold monetary action last month by the US Federal Reserve and ECB will prove short-lived unless underlying economic problems facing advanced countries are resolved, PIMCO chief executive Mohamed El Erian has warned.
El Erian told Emerging Markets in an exclusive interview that a “comprehensive” set of policies is needed to combat persistent economic woes in the eurozone and the US for which monetary measures were “either too blunt or ineffective.”
Central banks “are bridges and not destinations in themselves,” he added. “If governments and their political bosses do not step up to their responsibilities, the global economy will unfortunately remain vulnerable to stall speed and periodic deficit and debt scares.”
Although risk appetite has returned to global markets “this is yet to be accompanied by the much-needed return of private capital to troubled countries and market segments,” El Erian said.
He said ad hoc policy measures must now be accompanied by “a comprehensive set of policies that address the underlying problems of several western economies.” But he added: “These things cannot be changed overnight.”
El Erian said that although policymakers had made “enormous progress” in recent months in tackling the eurozone crisis, implementing closer fiscal, banking and political integration still remained “far from straightforward.”
He said that public support for such reforms was “far from uniform” across the single currency area – a fact which could lead some countries to exit the eurozone. “The political narrative is yet to converge fully,” he said. “It would not surprise me if the current 17-country membership were to give way to a somewhat smaller and less imperfect eurozone.”
El-Erian said that US economic woes further complicated the global economic outlook.
Although a fresh round of quantitative easing by the Fed – QE3 –is not the solution to US economic ills, he acknowledged that “with other policymaking entities basically paralyzed” the central bank had “little choice.”
“This could well be the most extreme and prolonged period of central bank experimentation in modern economic times” for which there are no precedents, he said.
There is a 60-70% chance US lawmakers would strike a “partial compromise” after elections next month to avoid a “disorderly contraction” of 4% of GDP when the economy falls off a so-called fiscal cliff when a number of tax cuts and spending measures expire in January, El Erian said.
Such a deal would see a fiscal contraction of some 1-1.5% of GDP next year, “something the economy could absorb while maintaining an overall growth rate not too dissimilar from what it recorded in the second quarter,” he added.
Despite a handful of lawmakers striving for bipartisan solutions, “they are yet to reach a critical mass,” El Erian said.