The Federal Open Market Committee's latest easing was not appropriate nor is it likely to help the economy much, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Tuesday.
"I opposed the Committee's actions in September because I believe that increasing monetary policy accommodation is neither appropriate nor likely to be effective in the current environment," Plosser told the CFA Society of Philadelphia and The Bond Club of Philadelphia, according to prepared text released by the Fed. "Every monetary policy action has costs and benefits, and my assessment is that the potential costs and risks associated with these actions outweigh the potential meager benefits."
He said a slow recovery isn't surprising "given the magnitude and nature of the shocks that hit our economy."
It will take time for the housing and financial sectors to recover. And while the jobs market remains depressed, "it is not at all clear that monetary policy can speed up that transition."
The easing, Plosser said is "unlikely to reduce long-term interest rates by a significant amount; some studies suggest that the effect will be quite small and transitory," and he said he doesn't believe the few basis points interest rates will drop "will spur further growth or higher employment."
Generally, business leaders are concerned about the future, especially "uncertainty about fiscal decisions - here and abroad," which has made them hold off on adding staff. "Hopefully these uncertainties will abate over time, but the central bank can do little to alleviate them," Plosser noted.
While the situation in Europe has simmered down, "many fundamental issues remain unresolved," and the U.S. needs to avoid "falling off the fiscal cliff."
But, he noted the crisis has "abated" and the economy is recovering, even if the place is slower "than we would like."
Saying that more easing won't have a major impact on healing the economy, Plosser added, "If I am right, then conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed's credibility. This is quite costly: If the public loses confidence in the central bank, our ability to set effective monetary policy in the future will be harmed and households and businesses will feel the consequences."
He added, "The recent actions risk the Fed's credibility in other ways as well. The rationale for the actions leading to increased spending today depends on the Fed's ability to convince the public that it will conduct policy in a fundamentally different way than it has in the past. People must believe that we will delay raising interest rates compared to when we normally would and, by so doing, make the economy stronger than it otherwise would be. At the same time, people must believe that we will ensure that inflation expectations do not take off and threaten longer-run price stability. Making such a change in the policy regime believable will be very hard to do. If the public doesn't believe that we will delay raising rates, they won't bring spending forward and the policy will be ineffective. But if they do believe we will delay raising rates, they may infer that the Fed is willing to tolerate considerably higher inflation. This may spur an increase in inflation expectations, which would require a response from the FOMC, or else risk the credibility of its commitment to keep inflation low and stable. I do not think it prudent to risk that hard-won credibility. The subtlety and complexity of successfully managing expectations in this manner make this quite a risky policy strategy in my view, with little evidence of quantitatively meaningful results for employment."
Turning to the Fed's balance sheet, Plosser said, the latest expansion will make the exit even more difficult, "risking higher inflation and harm to the Fed's reputation and credibility." It is easier to lower rates than raise them, he noted.
"While these risks are very hard to quantify, it is clear that the larger the Fed's portfolio becomes, the higher the risk and the potential costs when it comes time to exit," he argued. "And based on my economic outlook, that time may come well before mid-2015. In my view, to keep the funds rate at zero that long would risk destabilizing inflation expectations and lead to an unwanted increase in inflation. In fact, some are interpreting the FOMC's statement that we will keep accommodation in place for a considerable time after the recovery strengthens as an indication that the Fed is focused on trying to lower the unemployment rate and is willing to tolerate higher inflation to do so. This is another risk to the hard-won credibility the institution has built up over many years, which, if lost, will undermine economic stability."
