Federal Reserve Bank of Richmond President Jeffrey Lacker, who voted repeatedly last year against expanding stimulus, said the Fed’s $3.72 trillion-dollar balance sheet and guidance on the likely path of interest rates increase the risks and costs of policy mistakes.
“My concern is that the combination of forward guidance and a very large balance sheet has raised the likelihood of policy mistakes going forward, and also has raised the cost of such mistakes, should they occur,” Lacker said today in a speech at the Swedbank Economic Outlook Seminar in Stockholm.
The Fed has expanded its balance sheet to a record level to hold down long-term interest rates and stoke economic growth. Policy makers last week refrained from reducing $85 billion in monthly bond buying, saying they need to see more evidence of lasting improvement in the economy.
The Federal Open Market Committee also affirmed its plan, known as “forward guidance,” to keep the main interest rate between zero and 0.25 percent so long as unemployment remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent. The FOMC released a statement on Sept. 18 after a two-day gathering.
Lacker, 57, dissented against FOMC decisions at all eight policy meetings last year, including the announcement of a third round of quantitative easing last September.
The economic gains from bond buying by the Fed “have been minimal,” Lacker said today in the text of prepared remarks. He won’t hold a policy vote again until 2015.
The FOMC has faced difficulty ensuring the public differentiates between its communications about the asset purchases and its guidance about the likely path of the benchmark interest rate, Lacker said.
“Both asset purchases and interest-rate settings reflect the central bank’s reading of economic prospects,” Lacker said. “A change in one policy will inevitably be attributed to some extent to a change in the central bank’s views on economic conditions, which will in turn be informative about the likely path of the other policy instrument.”
While increasing its balance sheet by purchasing Treasuries and mortgage-backed securities, the central bank has also held the benchmark lending rate near zero since December 2008. The Fed faces constraints in providing additional stimulus while confronting the so-called “zero lower bound.”
The FOMC sees as appropriate holding down interest rates “for a considerable time after the asset-purchase program ends and the economic recovery strengthens,” Lacker said, citing a commitment by the panel. Such language may be interpreted as “promising” lower short-term interest rates than normal policy “would dictate,” he said.
“Surely it indicates a willingness to tolerate a greater risk of keeping rates too low for too long,” Lacker said, adding that he doesn’t doubt the committee will defend its 2 percent inflation target.
“The need for vigilance regarding the emergence of these risks suggests that we pay more attention to monetary and bank credit aggregates than we typically do in more conventional times,” he said.
Lacker also criticized the Fed’s purchase of mortgage-backed securities as channeling credit to a specific segment of the economy.
“When a central bank uses its independent balance sheet to choose among private sector assets, it invites special pleading from interest groups and risks entanglement in distributional politics,” Lacker said.
“Of the risks associated with unconventional monetary policies, those associated with central bank holdings of unconventional asset classes may be the most consequential,” he said.