Federal Reserve Bank of New York President William C. Dudley said he has not decided whether the Fed’s next move should be to enlarge or shrink its bond buying program as he called for a fresh look at its eventual retreat from record asset purchases.
“Because the outlook is uncertain, I cannot be sure which way -- up or down -- the next change will be,” Dudley said in a speech today in New York.
Dudley adds his voice to a debate on the Federal Open Market Committee about what to do with its program of bond purchases, designed to lower the 7.5 percent unemployment rate. While many Fed officials have voiced support for shrinking purchases as the next step, Dudley, who is also vice chairman of the FOMC, signaled willingness to increase purchases.
Officials last week expressed a range of views on the program. Philadelphia Fed President Charles Plosser called for shrinking purchases at the Fed’s next meeting; San Francisco’s John Williams favored a reduction “perhaps as early as this summer.” By contrast, Boston’s Eric Rosengren said low inflation and high unemployment suggest there may be a need for even more stimulus, not less.
Stocks extended gains after Dudley’s comments. The Standard & Poor’s 500 Index climbed 0.2 percent to 1,669.16 after earlier declining as much as 0.2 percent. The yield on the 10-year Treasury note fell to 1.93 percent from 1.97 percent late yesterday.
The FOMC’s next policy-setting meeting is scheduled for June 18-19. “We have to think that QE is going to stick around for a while and when we go into the June meeting we probably shouldn’t expect tapering,” said Christopher Low, chief economist at FTN Financial in New York.
Earlier today, St. Louis Fed President James Bullard said the central bank should continue its bond buying because it’s the best available option for policy makers to boost growth that is slower than expected.
The purchases known as quantitative easing should be maintained because financial markets indicate that they are improving financial conditions and can be adjusted based on how the economy changes, Bullard, who votes on the policy-setting Federal Open Market Committee this year, said in the text of remarks prepared for delivery in Frankfurt.
“Quantitative easing is closest to standard monetary policy, involves clear action and has been effective,” Bullard said. The panel should continue the program while “adjusting the rate of purchases appropriately in view of incoming data on both real economic performance and inflation.”
In discussing the next steps for the stimulus program, Dudley said the Fed may need to overhaul its plan to eventually normalize monetary policy, which was adopted in 2011.
“We may need to update our thinking with respect to the so-called exit principles,” Dudley said. The strategy said the Fed would stop reinvesting the assets on its balance sheet, raise short-term interest rates, and finally sell mortgage-backed securities. “This seems stale in several respects,” he said.
Dudley said that the strategy is outdated because policy makers have since pledged to hold their target interest rate near zero until unemployment falls to 6.5 percent. He also said the central bank may want to abandon its plan to sell mortgage-backed securities eventually.
“To the extent that the committee wants to reduce the risk of disrupting market functioning during normalization, it could decide to indicate that it will avoid selling the MBS portfolio during the early stages of the normalization process,” Dudley said. “Moreover, to the extent that the committee wants to mitigate the risk of a sharp increase in long-term rates, it could judge that it would prefer not to commit to agency MBS sales.”
The Fed announced $40 billion of monthly mortgage bond purchases in September and added $45 billion of monthly Treasury purchases in December, bringing total purchases to $85 billion a month. Those efforts have pushed the Fed’s balance sheet to a record $3.35 trillion.
Dudley spoke to the Japan Society in New York, and his remarks offered reflections on the experience of central banks such as the Fed and the Bank of Japan that have lowered their target interest rates near zero and still been unable to generate a full-fledged economic recovery.
The Bank of Japan, led by Governor Haruhiko Kuroda, announced last month that it would double the monetary base as part of a plan to end more than a decade of deflation that has weighed down the world’s third-largest economy. Prices excluding fresh food haven’t risen 2 percent in any year since 1997, when a sales tax was increased.
Responding to a question from the audience about U.S. inflation, Dudley said he’s not too concerned about a slowing rate of price gains and that he’d be “surprised” if it eased further. Inflation expectations are still anchored, he said, adding that “I’m watching it.”
Dudley also said the Fed’s policy approach has been “far from perfect,” and that the central bank was overly optimistic about growth prospects in the 2009-2012 period.
“With the benefit of hindsight, we did not provide enough stimulus,” he said. “Perhaps, if we had paid more attention to the persistent divergence between growth forecasts and outturns in Japan in the 1990s, we might have been more skeptical about the prospects for a strong economic recovery, even with a more aggressive monetary policy regime.”
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