Federal Reserve Bank of Philadelphia President Charles Plosser said keeping the benchmark interest rate low through mid-2015 risks unleashing inflation, and borrowing costs may have to be raised before then.
“To keep the funds rate at zero that long would risk destabilizing inflation expectations and lead to an unwanted increase in inflation,” Plosser said today in a speech in Avondale, Pennsylvania. “Chasing an elusive goal for unemployment could well risk losing control over inflation. That was the lesson of the Great Inflation during the 1970s.”
Plosser, who doesn’t vote on monetary policy this year, said the central bank may have to tighten policy “well before mid-2015,” given his outlook for a 3 percent pace of growth over the next two years and a gradual decline in the unemployment rate, which unexpectedly fell to 7.8 percent in September, the lowest since January 2009.
Plosser said he opposed last month’s decision by the Federal Open Market Committee to extend its horizon for low interest rates from late 2014 and to start a third round of large-scale asset purchases, known as quantitative easing. The Fed is buying $40 billion of mortgage-backed securities per month, and for the first time it didn’t specify an end-date for the program, intended to boost growth and reduce unemployment.
“In general, central banks should refrain from allocating credit toward one sector or industry,” Plosser said. “Those types of credit-allocation decisions rightfully belong to the fiscal authorities, not the central bank. Engaging in such actions endangers our independence and the effectiveness of monetary policy.”
The Philadelphia Fed chief said asset purchases probably won’t reduce long-term interest rates “by a significant amount,” and that a decline in rates of “a few more basis points” won’t spur growth or generate more jobs.
“We know that monetary policy can control inflation, but its ability to manage the unemployment rate is far more dubious,” he said.
“Interest rates are at historic lows, and markets are generally functioning well,” Plosser said in the speech to the Southern Chester County Chamber of Commerce. “I do not believe a lack of monetary accommodation is restraining near-term growth prospects.”
The world’s largest economy expanded at a 1.3 percent pace from April through June, slower than a prior estimate of 1.7 percent, after growing at a 2 percent rate in the first quarter. Economists expect gross domestic product to grow 1.8 percent in the third quarter and 1.9 percent in the fourth, according to the median of 91 estimates in a Bloomberg survey.
The district bank’s gauge of manufacturing in the Philadelphia region is “inching its way back up,” and many small manufacturing firms “are doing quite well,” Plosser told reporters after his speech.
“I talked to some just yesterday who were quite positive,” Plosser said. “What they’re saying is it’s not as good as it was earlier in the recovery, but they’re still making progress.”
The Philadelphia Fed’s general economic index improved to minus 1.9, higher than forecast, from minus 7.1 in August. Readings less than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware.
The September jobs report “was mostly good news,” Plosser said. “It suggests that while we still have a long way to go, we are gradually making progress, even if it’s slow.”
Stocks rose after a report from the Labor Department showing that initial claims for unemployment benefits declined last week to a four-year low. The Standard & Poor’s 500 Index climbed 0.2 percent to 1,435.24 at 3:38 p.m. in New York.
The Fed cut its benchmark interest rate almost to zero in December 2008 and has since used asset purchases to lower long-term borrowing costs.
In the first round, starting in 2008, the Fed bought $1.25 trillion of mortgage-backed securities, $175 billion of federal agency debt and $300 billion of Treasuries. In the second round, announced in November 2010, the Fed bought $600 billion of Treasuries.
Plosser, 64, became president of the Philadelphia Fed in August 2006. He was previously dean of the graduate school of business administration at the University of Rochester in New York State. The Philadelphia Fed will next have a vote on policy decisions in 2014.