Brian Sack, the Federal Reserve Bank of New York’s markets group chief, said a further expansion of the central bank’s balance sheet would help stimulate an economic recovery that is forecast to be “relatively tepid.”
“The expansion of the securities portfolio to date has helped to foster more accommodative financial conditions, and further expansion would likely provide additional accommodation,” Sack said in a speech today to a CFA Institute conference in Newport Beach, California.
“Balance-sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be,” Sack said.
Central bank policy makers are debating how to deploy tools for more stimulus after the Federal Open Market Committee said on Sept. 21 that it’s prepared to take action “if needed” to spur growth and achieve its mandate of stable prices and full employment.
New York Fed President William Dudley said last week that the outlook for U.S. job growth and inflation is “unacceptable” and that the Fed will probably need to take action, one of the clearest signs that policy makers will start a second round of unconventional accommodation as soon as the FOMC’s meeting Nov. 2-3. Fed Chairman Ben S. Bernanke also said last week that the central bank has a duty to aid the economy.
“The economy remains vulnerable to downside surprises that could take both output and inflation further away from the FOMC’s objectives,” Sack said.
U.S. stocks dropped and two-year Treasury yields fell to a record low after reports on American home sales and factory orders failed to assuage concerns that the recovery is slowing. The Standard & Poor’s 500 Index lost 1 percent to 1,134.30 at 12:50 p.m. in New York and the yield on the two-year Treasury note fell as low as 0.3987 percent.
Lowering long-term interest rates by restarting purchases of Treasuries or mortgage debt would have a “significant” effect on the economy by supporting the value of homes and stocks, making housing and refinancing mortgages more affordable and reducing the cost of capital for businesses, Dudley said last week.
The impact of expanding the central bank’s balance sheet “remains a point of ongoing debate,” Sack said. It is “difficult to calibrate” the costs and benefits of additional bond purchases, he said.
‘Old-Fashioned Monetary Policy’
“If we were talking about good old-fashioned monetary policy” there’s “a lot of disagreement about that,” Sack said in response to audience questions. “Here, we’re talking about using an instrument that we don’t have a lot of experience with, so it’s natural that there are differing opinions.”
Philadelphia Fed President Charles Plosser said last week that the central bank risks its credibility by taking actions, such as additional asset purchases, that may fail to help the labor market.
In contrast, Dudley said last week that buying about $500 billion of securities, for example, would add as much stimulus as reducing the Fed’s benchmark rate 0.5 percentage point to 0.75 percentage point, depending on how long investors expect the Fed to hold the assets. The Fed has kept the rate near zero since December 2008.
A second round of bond purchases may merit a different strategy than the central bank’s earlier program at the height of the financial crisis, when the Fed used “infrequent but large increments” to expand its balance sheet, Sack said.
“That might have been appropriate in circumstances when substantial and front-loaded policy surprises had benefits, but different approaches may be warranted in other circumstances,” Sack said. “Indeed, it contrasts with the manner in which the FOMC has historically adjusted the federal funds rate, which has typically involved incremental changes to the policy instrument.”
As the central bank would also be “learning about the costs and benefits of its balance-sheet changes as it implemented a new program,” that “might call for some flexibility to be incorporated into the program, providing some discretion to change course as market conditions evolve,” Sack said.
While buying securities would increase the interest-rate sensitivity of the central bank’s portfolio, the Fed’s goal would be to stimulate the economy, not generate profits, Sack said.
“There should be no confusion, no mistake, that we’ve put duration risk onto the Fed’s balance sheet,” Sack said. “These decisions are being made to produce economic outcomes” not “to produce a certain return on the portfolio.”
If the central bank were to suffer losses “it has no operational consequences on our ability to conduct monetary policy,” he said.
Sack dismissed concern that restarting bond purchases would impair the central bank’s ability to exit the unprecedented stimulus. Dudley said last week that a “credible plan” to withdraw liquidity would counter the risk that inflation expectations rise.
“I am confident that our ability to exit will not be compromised by any further expansion of the balance sheet,” Sack said. “In all potential circumstances, the Federal Reserve should be able to tighten financial conditions to a sufficient degree when appropriate. The ability to pay interest on reserves, in combination with the ability to drain reserves as needed, will give us sufficient control of short-term interest rates.”
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