March 6 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank should slow the pace of its bond purchases because the potential costs from more stimulus outweigh the benefits.
“We should begin to taper our asset purchases with an aim of ending them before year-end,” Plosser said today in a speech in Lancaster, Pennsylvania. “With interest rates already extremely low and the Fed’s balance sheet large and growing, monetary policy is posing risks to the economy in terms of financial stability, market functioning and price stability.”
The Federal Open Market Committee is debating how long it should continue $85 billion in monthly purchases of Treasuries and mortgage bonds aimed at boosting economic growth and reducing 7.9 percent unemployment. Chairman Ben S. Bernanke and Vice Chairman Janet Yellen in speeches this month affirmed a commitment to record stimulus pushing the central bank’s balance sheet beyond $3 trillion.
Even with the easing, the economy expanded just 0.1 percent in the fourth quarter amid the biggest drop in defense spending since the closing years of the Vietnam War.
“Beneath the very weak headline number, there were some signs of improvement in consumption, business investments and residential investments,” Plosser said. “Thus, there is reason to be somewhat optimistic for the coming quarters.”
Plosser said to reporters after the speech that it’s too soon to know whether the Fed can withdraw easing by holding assets until maturity instead of selling them.
“I don’t know how we can commit to never selling,” Plosser said. “We don’t know the answer to that, so it’s hard to pre-commit, to say we can’t sell assets even in the face of rising inflation.”
Bernanke said in congressional testimony on Feb. 26 that the central bank may be able to exit from its record easing by holding the assets it owns until they mature. “We could exit without ever selling by letting it run off and we could tighten policy by raising interest rates we pay on reserves,” he said in testimony to the Senate Banking Committee in Washington.
Plosser told reporters that he would like the monthly purchases “to be tapered fast enough so that we are done before the end of this year.”
The Dow Jones Industrial Average rose to a record for a second day after a report from the ADP Research Institute showed U.S. employers added 198,000 jobs last month, exceeding the median economist forecast for 170,000. The index reached 14,281.22 at 10:58 a.m. in New York, while the yield on the benchmark 10-year Treasury note rose 0.02 percentage point to 1.92 percent.
In his speech, the Philadelphia Fed chief predicted the economy will grow about 3 percent this year and next. Economists expect the U.S. economy to expand at a 1.8 percent rate this year and accelerate to 2.7 percent next year, according to the median of 77 forecasts in a Bloomberg survey.
Plosser, who doesn’t hold a vote this year on the policy-setting FOMC, said accommodation may be fueling excessive risk-taking and that financial instability may “arise from the higher levels of interest-rate risk” taken by investors. The Fed’s expanding role in the mortgage-bond market may also “distort the functioning” of the market over time, he told the Economic Development Company of Lancaster County.
“Our current, increasingly accommodative monetary policy has the potential to complicate the Fed’s exit from the nontraditional policies and undermine its ability to achieve long-run price stability,” Plosser said. While the Fed has the tools to withdraw stimulus in a high-reserves environment, “there remains some uncertainty about their effectiveness, since we do not have historical experience.”
The Fed may take losses on its holdings when interest rates rise, which would not “go unnoticed” and may pose a threat to the central bank’s independence should lawmakers seek to interfere with monetary policy as a result, he said.
Plosser said Feb. 13 he expects the unemployment rate to decline close to 7 percent by the end of the year, warranting a reduction in the Fed’s monthly bond purchases. The jobless rate rose to 7.9 percent in January. It has fluctuated between that level and 7.8 percent since September.
“My forecast of 3 percent growth should allow for continued improvements in labor market conditions, including a gradual decline in the unemployment rate, similar to the improvements we have seen over the past two years,” Plosser said. He predicted inflation will be near the Fed’s 2 percent goal during the medium to longer term.
The central bank in December linked the benchmark interest rate to economic indicators for the first time, pledging to hold rates near zero as long as projected inflation doesn’t exceed 2.5 percent and unemployment exceeds 6.5 percent.
Plosser, 64, became president of the Philadelphia Fed in August 2006. He was previously dean of the business school at the University of Rochester in New York state. The Philadelphia Fed will next have a vote on policy decisions in 2014.
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