Federal Reserve policy makers are now debating how to deploy tools for more unconventional easing as two top officials indicated action may be needed to lower unemployment persisting near 10 percent.
“Further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long,” New York Fed president William Dudley said yesterday.
His comments, following Chairman Ben S. Bernanke’s statement on Sept. 30 that the Fed has a duty to aid the economy, indicate that the outlook has weakened enough for action, said former Fed Governor Laurence Meyer. Dudley, vice chairman of the Fed’s policy-setting Open Market Committee, said additional securities purchases can have a “significant” effect on the economy.
“The threshold is met,” said Meyer, vice chairman of Macroeconomic Advisers LLC in Washington. The details of how the Fed eases further are “the most important question that’s on my mind,” he said. “It’s going to be an amount that is high enough to say, they really mean it now.”
The FOMC meets on Nov. 2-3, giving members time to digest reports on September employment, retail sales and inflation.
“They have decided to do another round of quantitative easing,” said Dino Kos, managing director at Portales Partners LLC in New York and former executive vice president in charge of markets at the New York Fed. “The only thing left to fight over is how they do it.”
The dollar fell to the lowest level since March versus the euro and dropped against the yen after Dudley’s comments. The Treasury two-year yield was 0.41 percent after falling to a record-low of 0.4066 percent.
Government reports yesterday showed U.S. manufacturing expanded at a slower pace, while consumer spending increased, underlining the Fed’s forecast for a “modest” pace of economic growth.
Dudley said that $500 billion of purchases, 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. Officials can’t lower the rate further because it’s already close to zero.
The speech is “a strong indication that the next statement is going to announce purchases,” said Jan Hatzius, who succeeded Dudley as chief U.S. economist at Goldman Sachs Group Inc. In a research note, Goldman Sachs said the amount of announced purchases is likely to be $500 billion.
Dudley’s comments indicate Fed officials aren’t willing to tolerate a pace of recovery that’s showing few signs of lowering the unemployment rate from close to a 26-year high or lifting the inflation rate.
The economy expanded at a 1.7 percent annual pace in the second quarter, down from 3.7 percent in the previous three months. The Fed’s preferred inflation benchmark rose 1.4 percent for the 12 months ending August, below the FOMC’s preferred range of 1.7 percent to 2 percent.
“Both the current levels of unemployment and inflation and the timeframe over which they are likely to return to levels consistent with our mandate are unacceptable,” Dudley said yesterday.
Those remarks echoed Bernanke’s comments to economists at Princeton University Sept. 24. “A concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment,” he said.
The comments mark a shift from Bernanke’s Aug. 27 statement that more action would be called for if “the outlook were to deteriorate significantly.”
Meyer said St. Louis Fed President James Bullard may be influencing colleagues with his call for a quantitative rule to determine the suitable amount of asset purchases and to adjust the balance sheet based on the FOMC’s judgments about progress on growth and inflation. Bullard said in August he would favor gradual adjustments to the purchase program rather than a “shock and awe” policy.
Another option is for the Fed to announce an explicit inflation goal and then, if price increases are too slow, potentially aim to overshoot the goal in future years, Dudley said. One risk is that investors may “mistakenly” conclude that the Fed was “tinkering with its long-run inflation objective,” undermining the change in policy.
Less than seven months ago, Bernanke was testifying before the House Financial Services Committee on the central bank’s exit strategy. Since then, financial turmoil in Europe and a weak hand-off from inventory re-stocking to consumer spending in the U.S. have produced two quarters of growth that have kept the unemployment rate at 9.5 percent or higher.
Textron Inc., based in Providence, Rhode Island, last month said it plans to cut 700 jobs at its Cessna plane division, as the aircraft maker reduces production further because demand hasn’t picked up after the recession. The cuts represent about 8.3 percent of the unit’s workforce.
U.S. central bankers began to focus on their mandate to achieve stable prices and full employment in their September statement as it became apparent that the risk of another year of moderate growth combined with waning fiscal policy could result in more under-shooting on jobs and prices.
Sluggish growth leaves the economy more vulnerable to a recession and in the event of a shock, deflation risks could increase. Further declines in inflation would constitute an increase in interest rates in the absence of further Fed action.
Some policy makers this week expressed skepticism about the need for further easing.
Dallas Fed President Richard Fisher said in a speech yesterday that the benefits of action may not outweigh the costs unless “fiscal and regulatory authorities are able to dispel the angst that businesses are reporting.”
Philadelphia Fed President Charles Plosser said Sept. 29 that he doesn’t see how additional asset purchases will help employment in the near term, and Narayana Kocherlakota of the Minneapolis Fed said it would probably have a “more muted effect” than purchases that ended in March.
Other officials who indicated this week that they favor further easing include Boston Fed President Eric Rosengren, who said Sept. 29 the Fed should respond “vigorously, creatively, thoughtfully and persistently” to a slow recovery, and Chicago Fed President Charles Evans, who said yesterday more action may be “desirable.”
The FOMC will have two additional voters at the November meeting who are likely to buttress any decision to ease policy, Vincent Reinhart, former Fed monetary-affairs director, said this week. The Senate on Sept. 29 confirmed San Francisco Fed President Janet Yellen for vice chairman and Sarah Bloom Raskin for a governor position.
Since Bernanke’s Aug. 27 speech at Jackson Hole, Wyoming, yields on the 10-year Treasury note have fallen 13 basis points to 2.51 percent, and the Standard & Poor’s 500 stock index is up 7.7 percent.
“Investors are buying into the strategy,” said Kos, who noted that prospects for further quantitative easing have depreciated the dollar without a rise in Treasury yields that foreign investors typically demand to compensate for currency risk. “You worry that at some point they don’t. A loss of credibility in central banking is really difficult to recover from.”