Federal Reserve Bank of Philadelphia President Charles Plosser said the Fed may need to raise the main interest rate this year, and last week’s pledge to keep rates near zero through late 2014 isn’t a firm commitment.
“The statement is pretty clear that late 2014 is contingent on the evolution of the economy,” Plosser said today in an interview on CNBC. “It is not a commitment and it shouldn’t be interpreted as a commitment. It will depend on how the economy” evolves, he said.
The Fed on Jan. 25 released federal funds rate forecasts by policy makers for the first time as it extended its pledge to keep rates near zero at least through late 2014. The central bank had previously said it would keep borrowing costs low at least until the middle of 2013.
Plosser said he was one of three policy makers to project that it may be appropriate to raise the benchmark rate this year. He is not a voting member on the Federal Open Market Committee in 2012.
The Fed pushed down the rate close to zero in December 2008 and has engaged in two rounds of asset purchases totaling $2.3 trillion to boost the economy and reduce the jobless rate, which stood at 8.5 percent in December.
“This has been his view for a while that the size of the balance sheet is problematic and monetary conditions are too loose relative to the state of the economy,” said Michael Gapen, a senior economist at Barclays Capital in New York and former staff member of the Fed Board’s Division of Monetary Affairs.
Gist of Argument
“The gist of this argument is that the statement is too pessimistic on the outlook” and “therefore, promising a low Fed funds rate until late-2014 is excessive in his view,” Gapen said.
U.S. economic growth of about 3 percent in 2012 will probably reduce the unemployment rate to about 8 percent at year’s end, Plosser said. The FOMC should be patient and cautious when weighing additional easing, he said.
Chairman Ben S. Bernanke said in a press conference last week that the Fed is considering buying more bonds.
Benchmark 10-year yields dropped six basis points, or 0.06 percentage point, to 1.83 percent at 11:20 a.m. New York time, according to Bloomberg Bond Trader prices. Five-year debt yielded 0.73 percent, after reaching a record low of 0.7157 percent.
“I worry about this accelerationist view that we have to go ever faster on the pedal of monetary policy,” Plosser said. “You run the risk of runaway inflation, distortions in the marketplace, bubbles and so forth.”
Rates near zero are “punishing savers” and could be leading portfolio managers to take “unwise risks,” Plosser said. While the Fed’s goal has been to encourage a move to riskier assets, “we don’t know the full consequences of that,” he said.
The Fed’s program to extend the average maturity of assets in its portfolio, known as Operation Twist, could also have unintended consequences, the Philadelphia Fed leader said. “We don’t quite know what distortions it has created,” he said.
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