Dudley Says Fed Won’t Make ‘Hasty’ Exit From Stimulus

Federal Reserve Bank of New York President William C. Dudley
Federal Reserve Bank of New York President William C. Dudley said, “With the benefit of hindsight, monetary policy needed to be still more aggressive.” Photographer: Scott Eells/Bloomberg

Federal Reserve Bank of New York President William C. Dudley said the central bank won’t cut back record monetary stimulus too quickly when the economy begins to gain strength.

“If we were to see some good news on growth I would not expect us to respond in a hasty manner,” Dudley said in a speech today in New York.

Policy makers last month increased accommodation to boost an economy that central bankers said still faces “significant downside risks.” Fed officials announced a third round of asset purchases, agreeing to buy $40 billion of mortgage-backed bonds each month, and extended the horizon for record-low interest rates through at least the middle of 2015.

The Fed may have not used enough stimulus measures to support the recovery in the aftermath of the financial crisis, Dudley said to the National Association for Business Economics.

“With the benefit of hindsight, monetary policy needed to be still more aggressive,” he said. “Consequently, it was appropriate to recalibrate our policy stance, which is what happened at the last” meeting of the Federal Open Market Committee.

Monetary policy may have been “less powerful than normal” because of the impairment of the housing market, and because the “impetus from a given level of monetary accommodation likely has become attenuated -- that is, less powerful -- over time,” said Dudley, who is vice chairman of the FOMC.

The Fed has kept its benchmark interest rate near zero since December 2008.

Policy Response

“The potential for the monetary policy impulse to be attenuated over time is an additional reason to be aggressive in terms of the policy response,” Dudley said.

“A more front-loaded program would avoid greater attenuation compared to a policy that started out less aggressive but added stimulus gradually over time,” he said. That would have more likely worked to generate “the desired recovery more quickly” and would result in less ultimately needing to be done.

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 predict gross domestic product will grow 1.8 percent in the third quarter and 1.9 percent in the fourth, according to the median of 82 estimates in a Bloomberg survey conducted Oct. 5 to Oct. 10.

After Crisis

The “weakness of foreign demand,” the “dynamics following financial crises,” shocks to the economy, demographic factors and fiscal policies may have also contributed to a slower-than-expected recovery, Dudley said.

Dudley said in an interview with CNN today that he expects the Fed “to be accommodative for quite some time.” He forecast a “gradual strengthening” of the U.S. economy beginning next year, assuming the debt crisis in Europe and the so-called fiscal cliff that’s “hurting the economy” are resolved “in a good way.” The fiscal cliff refers to more than $600 billion of tax increases and federal spending cuts that will kick in automatically at the end of the year unless Congress acts.

Federal Reserve Bank of St. Louis President James Bullard said U.S. economic growth will probably pick up to 3.5 percent next year, which will bring the unemployment rate down to close to 7 percent.

“I still think it is reasonable to expect faster growth as we go forward,” Bullard said in a speech in St. Louis. “The normal expectation would be the effects start to dissipate” from headwinds that have included the European debt crisis and housing, he said.

‘Mixed’ Impact

Energy prices have had a “mixed” impact on the economic outlook as higher oil prices, lifted in part by “geopolitical concerns,” were offset by a decline in natural gas prices, Dudley said in response to an audience question.

“We would be happy to see oil prices drop if possible but I don’t think it’s a big impediment to the recovery,” Dudley said. “It’s true gasoline prices are very high and oil prices are very high, but on the other side of things, natural gas prices have come down pretty dramatically over the last couple years.”

He also said it’s “too soon” to make a “firm decision” about the trajectory of productivity in the U.S., while adding that there’s no cause to be “pessimistic” about it.

The Fed’s monetary policy does pose risks, and policy makers watch for them “on an ongoing basis,” Dudley said. Investor confusion about how the Fed will exit its unprecedented stimulus “could increase financial market volatility,” he said.

‘Asset Allocations’

“The current monetary policy regime could distort asset allocations and lead to a renewed financial asset bubbles,” Dudley said. “There is little evidence of problems or excesses, but this could change as the recovery proceeds.”

Dudley said in response to audience questions that while the Fed’s policies are affecting yields in the bond market, “to say that’s a bubble, I don’t think that’s quite right.” He said the debt market is a “lever of policy” for the central bank.

Federal Reserve Bank of Richmond President Jeffrey Lacker said the Fed’s decision last month to undertake a third round of bond buying will probably give the economy just a little boost because inflation may rise.

“The benefits of that action are likely to be small, because it’s unlikely to improve growth without also causing an unwelcome increase in inflation,” Lacker said today in a speech in Roanoke, Virginia. “Adding to our balance sheet increases the risk we will have to move quickly when the time comes to normalize monetary policy and begin raising rates.”

Downplayed Risks

Dudley downplayed such risks. While some observers have said the Fed’s balance sheet expansion “could ultimately prove inflationary,” those fears “are misplaced” because the central bank can keep price increases in check by paying interest on excess reserves, he said.

The central bank has considered lowering the interest rate it pays on bank reserves, and has so far concluded that the risks to disruptions in the short-term money markets outweigh the potential benefits, Dudley said.

The Standard & Poor’s 500 Index rose 0.8 percent to 1,440.13 in New York, after the benchmark gauge for American equities slumped 2.2 percent last week. The yield on the benchmark 10-year Treasury note increased 0.01 percentage point to 1.66 percent.

“Only as we became confident that the recovery was securely established would I expect our monetary policy stance to evolve to ensure that it remained appropriate to achievement of our objective: maximum sustainable employment in the context of price stability,” Dudley said.


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