Explaining the Pain

In emerging economies, central bankers have been raising interest rates and tightening credit growth, combating inflation by sacrificing some of today's growth. In industrial countries, central banks have increased their anti-inflationary rhetoric, causing markets to raise interest rates.

In normal times, the emphasis on monetary policy would be necessary and warranted. But conditions are far from normal in today's global economy. Pending progress in healing an injured financial system, especially in the U.S., such reactions are simply too blunt. Indeed, with the "transmission mechanism" largely inoperative, national authorities may legitimately pursue some well-intentioned policy objectives yet end up creating significant problems elsewhere. So, what should we expect in the coming weeks and months? I am afraid that the answer is more collateral damage to the global economy. This will occur through two distinct, but reinforcing channels.

First, tighter financial conditions, especially higher mortgage rates, will further undermine a U.S. housing market that is already collapsing under the weight of overvaluation, excessive inventories and growing foreclosures. The recent decision by the U.S. Congress to extend emergency assistance to mortgage holders and behemoth lenders (such as Freddie Mac and Fannie Mae) will only act as a short-term Band-Aid. In particular, it will prove inadequate to offset the headwinds facing American consumers who, for a number of years, constituted the "main" engine driving the global economy but are now struggling to overcome the combined impact of higher unemployment, declining living standards, and lower credit availability.

Second, growth in emerging economies will also decline as policymakers there realign their domestic priorities. For the global economy, this means slowing the "other" engines that, particularly in the past year, have accounted for a growing share of the increase in world GDP, thereby effectively compensating for the more sluggish U.S. economy.

Where does this leave us? The bottom line is that policymakers have no choice but to react to the food and energy price spikes. But in relaying overwhelmingly on tighter monetary policy, and in failing to aggressively pursue enhanced production and distribution channels for food and energy, they risk weakening global demand too much, thereby being potentially forced into a sudden reversal. The rest of us should keep our seat belts fastened as the global economy continues to navigate an even bumpier phase, as weakening growth impulses aggravate the impact of the credit crunch.
—El-Erianis co-CEO and co-CIO of PIMCO, and author of"When Markets Collide: Investment Strategies for a World of Global Economic Change"(McGraw Hill).

Unleash The World ' s Engineers
Chris Anderson believes that the price-cutting power of technology can still bring nations relief if only bureacrats will allow it to.