Plosser Says Easing Moves May Hurt Fed’s Credibility, Fail to Boost Growth
Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank may be undermining its own credibility by pushing forward with monetary easing that will do little to boost growth.
“The actions taken in August and September tend to undermine the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery,” Plosser said today in a speech in Radnor, Pennsylvania. “It is my assessment that they will not.”
Plosser’s remarks are his first since he joined Fed district bank presidents Richard Fisher of Dallas and Narayana Kocherlakota of Minneapolis in dissenting from a Fed decision for a second straight month. The regional Fed bank presidents pose the most opposition within the Federal Open Market Committee in almost 19 years, opposing last week a plan to sell $400 billion of short-term Treasury securities and buy $400 billion of longer-term securities.
The policy, so-called Operation Twist, is likely to reduce long-term rates by “less than 20 basis points” and “the pass- through to the rates at which consumers and businesses actually borrow is likely to be much less,” Plosser said at a Business Leaders Forum at the Villanova School of Business. “I am skeptical that this will do much to spur businesses to hire or consumers to spend.”
Plosser, Fisher and Kocherlakota also dissented when U.S. central bankers last month chose to hold interest rates near zero until at least mid-2013. That replaced their prior pledge to keep rates low for an “extended period.”
‘Cautious and Vigilant’
“In addition to having little effect, the actions come with significant potential costs,” Plosser said. “We should be cautious and vigilant that our previous accommodative policies do not translate into a steady rise in inflation over the medium term even while the unemployment rate remains elevated.”
Fed officials weighing in on the policy this week include Governor Sarah Bloom Raskin, who said the central bank’s use of tools has been “completely appropriate,” and Boston Fed President Eric Rosengren, who said he was “very supportive” of the Fed’s actions.
Atlanta Fed President Dennis Lockhart said this week that Operation Twist should have a “modest positive impact,” while Kansas City’s Tom Hoenig said it may “introduce new complexities and risk new unintended consequences.”
Plosser said to reporters after the speech that he “retains an open mind” on the idea of lowering the 0.25 percent rate the Fed pays financial firms on excess reserves.
“Reducing the interest rate on excess reserves at least in my mind would be a more traditional monetary policy action,” Plosser said. The Fed may not want to take such a step because of the uncertain effects from lowering the rate to zero, including possible damage to overnight lending markets, he said.
Plosser said he opposed the Fed’s decision, also announced last week, to reinvest its portfolio of housing debt back into mortgage-backed securities. The Fed had previously been replacing the housing debt with Treasury securities.
The new reinvestment scheme is a “credit allocation scheme designed to help one sector,” he said. The policy halts the process of normalizing the Fed’s balance sheet, he said. “As a result, when the time comes, it’s going to make our exit problem just that much more difficult.”
Job Market Boom
Bonds have rallied on the central bank’s actions, with the yield on the 10-year Treasury at 2 percent at 11:04 a.m. in New York trading, not far from the record low close of 1.72 percent on Sept. 22. Low interest rates haven’t sparked a job market boom. In August, the economy added no jobs and the unemployment rate remained unchanged at 9.1 percent. Economists in a Bloomberg Survey predict the rate will remain at 9.1 percent this month.
Plosser said he would consider further monetary stimulus “if deflationary fears were to become a real threat again.” If financial market disruptions from the European debt crisis became significant, the Fed may need to “respond in its role of lender of last resort,” he said.
“I do not see either of these scenarios in my forecast,” said Plosser, 63, a former professor and business-school dean at the University of Rochester in New York. He joined the Philadelphia Fed as its chief in 2006.
Plosser said he forecasts economic growth of around 2 percent in 2011, down from the 3 percent to 3.5 percent he expected earlier in the year. Growth should gradually accelerate to around 3 percent next year, he said.
“I do anticipate that with many commodity prices now leveling off or falling, and inflation expectations relatively stable, inflation will moderate in the near term,” he said. Unemployment will probably change little this year and decline to 8 percent to 8.5 percent by the end of 2012, he said. Inflation will decline to 2 percent next year or “maybe a little bit more,” he said to reporters.
“I’m not concerned about inflation in the near-term,” Plosser said. He said that market-based measures of inflation expectations, such as the difference between inflation protected Treasury securities and regular Treasury securities, may be distorted by a “flight to quality” into heavily-traded Treasuries.
Plosser renewed his calls for the Fed to adopt an explicit numerical target for inflation. He dismissed an idea similar to that proposed by Chicago Fed President Charles Evans to tolerate inflation higher than 2 percent to help bring unemployment down more quickly.
“I am very wary of such a strategy because I don’t believe we can control inflation expectations that precisely,” he said. “It is at least questionable whether we could credibly raise inflation expectations. And were we able to do so, how easily would we be able to bring them back down?”
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