Lacker Says Fed Policies Will Test Limits of Credibility

Federal Reserve Bank of Richmond President Jeffrey Lacker said further monetary stimulus is unlikely to boost growth and will “test the limits” of the U.S. central bank’s credibility.

The Federal Open Market Committee last month tied its outlook for borrowing costs to the jobless rate and inflation while boosting its monthly purchases of long-term assets to $85 billion a month. The central bank’s balance sheet will grow further from its current size of $2.92 trillion.

“At some point, we will need to withdraw stimulus by raising interest rates and reducing the size of our balance sheet, and the larger our balance sheet, the more vulnerable we will be to seemingly minor miscalibrations in policy,” Lacker said in prepared remarks to the Maryland Bankers Association in Baltimore.

Lacker told reporters after the speech that the Fed might have to move before inflation pressures emerge. Among the signals he will be watching for a need to exit are a “sustained pickup in the growth rate” of the economy with non-farm payrolls rising by more than 200,000 for several months in a row and gross domestic product rising by more than 3 percent for several quarters, he said.

The Richmond Fed president was a voting member of the committee last year and dissented at every meeting. Lacker dissented last month because Fed asset purchases were “unlikely to add to economic growth without unacceptably increasing the risk of future inflation,” minutes of the Dec. 11-12 meeting said.

Test Limits

In his remarks today, Lacker said he thinks that “further monetary stimulus is unlikely to materially increase the pace of economic expansion and that these actions will test the limits of our credibility.”

Lacker said he expects another year of moderate growth in 2013 with the economy still struggling under the restraints of uncertain federal tax and revenue policies, modest growth in housing markets, and tighter credit conditions.

“My sense is that there is substantial overhang of homes that are a poor match for what consumers want and can afford right now,” he said.

The FOMC on Dec. 12 decided to keep the main interest rate near zero as long as the jobless rate remains above 6.5 percent and the outlook for inflation rises no more than a half percentage point above the committee’s 2 percent goal one or two years in the future.

Inhibit Effectiveness

Lacker also dissented against linking the policy rate to unemployment and inflation thresholds because it could “inhibit the effectiveness of the committee’s communications and increase the potential for inflationary policy errors,” according to minutes of the Dec. 11-12 meeting.

The unemployment rate stood at 7.8 percent in December after employers added 155,000 workers to payrolls, following a gain of 161,000 in November.

The minutes also said that “several” members of the FOMC said it would “probably be appropriate to slow or stop purchases well before the end of 2013.” Lacker pointed to the FOMC statement as reference to what the committee ultimately agreed on in comments to reporters after his speech.

He told reporters there will be a constant evaluation of the asset purchase program and it could be “re-adjusted in terms of scale you know or even sort of suspension if the committee’s assessment of the relative costs and efficacy shifts.”

Reduced Need

“There are a number of things that could happen that could lead you to change your mind,” he said. That could range from the reduced need to continue the purchases as growth picks up, to changing perceptions about their efficacy, or the greater complication a growing balance sheet presents for the exit strategy. “Any of those things could shift the balance of considerations about costs and benefits over time,” he said.

Lacker told the Maryland bankers that he sees an increased risk that “inflation pressures emerge and are not thwarted in a timely way.”

The Fed’s goal for inflation is a 2 percent annual rate of increase in the personal consumption expenditures price index. The price benchmark slowed to a 1.4 percent pace for the 12 months ending November from 1.7 percent the previous month.

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