Dudley Says Central Banks Should Use All ‘Policy Tools’Joshua Zumbrun and Eric Martin
Federal Reserve Bank of New York President William C. Dudley said central banks can fend off political interference by using unconventional policies to spur economic growth.
“The best way for central banks to maintain their independence is to use all their available monetary policy tools to best achieve their objectives,” Dudley said in a speech today in Mexico City. “I do not see the use of these tools as creating significant new risks to our independence.”
Dudley defended unconventional policies at the core of Fed efforts to fuel the expansion and combat unemployment, which rose to 10 percent in 2009 and now persists at 7.3 percent. Chairman Ben S. Bernanke has held the Fed’s target interest rate near zero since December 2008 and pushed the central bank’s balance sheet to a record $3.76 trillion through three rounds of asset purchases, known as QE for quantitative easing.
“We’re missing by much more on the employment side of the mandate than the inflation side of the mandate,” Dudley said in response to an audience question, referring to the Fed’s goals of ensuring full employment and 2 percent long-run inflation.
The New York Fed chief, who is a permanent voter on monetary policy and serves as vice chairman of the Federal Open Market Committee, said fiscal mismanagement poses a greater risk to central bank independence. He spoke at a Banco de Mexico conference celebrating the Mexican central bank’s 20th year of independence.
“A far more important threat to central bank independence than the use of unconventional monetary policy is whether the fiscal authorities act in a manner consistent with the central bank’s objectives,” he said. “As recent history has shown, central banks may not be able to achieve their objectives when an inconsistent fiscal regime is in place.”
U.S. Senate leaders are poised to reach an agreement as early as today to bring a halt to a fiscal standoff, and must race the clock to sell the plan to lawmakers before U.S. borrowing authority runs out this week.
The emerging deal would stave off a potential default, end the 15-day-old government shutdown and change the immediate deadlines in favor of three new ones over the next four months. It’s far from complete as the Senate may delay passing the plan and House Republicans may seek to block or change it.
Dudley’s remarks differ from those of policy makers such as Richmond Fed President Jeffrey Lacker who have warned that unorthodox policies expose the Fed to more political risk.
The policy makers’ debate focuses on the Fed’s enlarged holdings of Treasuries and mortgage-backed securities, acquired during QE. The central bank uses the earnings on its bond portfolio to fund its operation.
With budgetary independence, the Fed doesn’t depend on appropriations from Congress, reducing political leverage over Fed policy. After funding its operations, the Fed remits its profits to the U.S. Treasury.
The central bank’s bond buying program does “create some budget risk for the Federal Reserve,” Dudley said.
The value of a bond drops when interest rates rise, and so the central bank’s portfolio could suffer unprecedented losses when Fed officials begin to tighten policy.
Richmond’s Lacker has said Fed purchases of mortgage bonds, which are aimed at boosting the housing market, make the central bank vulnerable to political meddling.
“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 last month. “Of the risks associated with unconventional monetary policies, those associated with central bank holdings of unconventional asset classes may be the most consequential.”
The Standard & Poor’s 500 Index fell 0.1 percent to 1,708.11 at 11:40 a.m. in New York, while the yield on the benchmark 10-year Treasury note increased 0.03 percentage point to 2.72 percent.
Dudley said that “the current size of the balance sheet would also discourage a premature interest-rate hike.”
“In the absence of solid improvements in labor market activity, a sharp increase in short-term rates would unnecessarily reduce the Federal Reserve net interest income without any benefits in terms of achieving” the Fed’s goals for maximum employment and 2 percent inflation, he said.