Federal Reserve Bank of Boston President Eric Rosengren said he sees a “strong case” for the central bank to buy bonds at the current monthly pace of $85 billion after its Operation Twist program expires.
“Given the tepid economic recovery, high unemployment, and subdued inflation -- and the uncertainty around fiscal policy -- I believe an accommodative monetary policy is quite appropriate,” Rosengren said today in a speech in New York. “We want to see continued improvement in labor markets in the near term, and monetary policy should encourage faster economic growth to achieve that objective.”
Policy makers, who next meet Dec. 11-12, are considering whether to step up record accommodation to offset the scheduled expiration this month of Operation Twist, a program swapping short-term Treasuries with longer-term debt. A “number” of Fed officials said at their policy meeting in October that additional monthly purchases of bonds may be warranted next year, according to the minutes of the Federal Open Market Committee’s Oct. 23-24 gathering.
The central bank is buying $40 billion in mortgage debt each month and has pledged to keep its benchmark interest rate near zero through mid-2015 to boost growth and reduce 7.9 percent unemployment. The Fed has also been swapping about $45 billion of short-term Treasuries on its balance sheet for longer-term debt under Operation Twist.
“Given the effectiveness of this policy and the relatively high unemployment rate and inflation that is running below our 2 percent target, I fully support the policy decisions to provide stimulus through asset purchases,” Rosengren said at a workshop on mortgage rates held at the Federal Reserve Bank of New York.
Stocks fell and commodities erased early gains as contraction in U.S. manufacturing and concern about the budget debate overshadowed optimism on China’s economy. The Standard & Poor’s 500 slid 0.4 percent to 1,411.09 at 2:50 p.m. in New York. Yields on benchmark 10-year Treasuries were little changed at 1.62 percent.
Including mortgage debt in the central bank’s first and third rounds of asset purchases has “contributed to a stronger economic outcome than we would have seen in the absence of these approaches,” Rosengren said.
“If the purpose is to improve market functioning, or to provide focused stimulus to an interest-sensitive sector in order to stimulate aggregate demand, it may be that MBS purchases are preferable to Treasury security purchases,” he said. Because Treasuries are “often preferred during times of crises,” their liquidity is less likely to be impaired.
New York Fed President William C. Dudley said in opening remarks for the workshop today that a wider gap between yields on mortgage-backed securities and home loans is reducing the potency of the central bank’s monetary stimulus.
While there is “solid evidence” the Fed’s monthly purchases of $40 billion in housing debt have been effective in lowering yields, “the impact of monetary easing on the economy through housing and mortgage finance has been impeded to some degree,” Dudley said today.
For the Fed’s stimulus to achieve its “full impact,” he said, lower yields on mortgage-backed securities must pass through to interest rates on home loans. “To the extent that the primary-secondary rate spread widens, the reduction in pass-through limits the full impact of the policy actions,” he said.
The difference between yields on Fannie Mae mortgage bonds lenders typically use to package new loans for sale and 30-year new-loan rates is more than 1.2 percentage point, about the same as when the Fed announced additional buying in September, according to data compiled by Bloomberg and Bankrate.com. That’s up from about 0.8 percentage point in March and compares with a median of about 0.4 percentage point during the last decade.
St. Louis Fed President James Bullard said in a speech today that replacing Operation Twist’s swap of Treasuries with outright purchases of the same amount of securities would represent a policy easing that could risk higher inflation.
“It is reasonable to think that an outright purchase program has more impact on inflation and inflation expectations than a Twist program,” he said in Little Rock, Arkansas. “If the goal is to keep policy on its present course, the replacement rate should be less than one-for-one.”
The Boston Fed chief said in response to audience questions that there were “positive surprises” from the central bank’s latest round of bond buying. Housing starts are “improving” and consumers are refinancing their home loans, he said.
“I’ve actually been favorably impressed” with the results, he said. “So far, the benefits have outweighed the costs.”
“The monetary policies designed to lower mortgage rates and stimulate more activity in interest-sensitive sectors have been effective, and are an important reason why the U.S. economy has performed better than many of our developed-country peers,” Rosengren said.
The Fed has so far decided that there’s a bigger benefit to purchasing mortgage-debt outright, instead of pursuing an Operation Twist-like program with its holdings of home-loan bonds, he said.