Speaking to the limits of monetary policy, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser warned of "significant risks" to the Fed's latest easing and reiterated that the move was "neither appropriate nor likely to be very effective in the current environment."
"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 benefits," he told the Southern Chester County Chamber of Commerce, according to prepared text of his speech, released by the Fed.
"The Fed's most recent actions carry significant risks. I am not forecasting that those risks will necessarily materialize, and I hope they will not. But if they do, they could prove quite costly to the economy," Plosser said. "It is therefore important that we understand those risks and evaluate them in assessing policy. A common error in policymaking is an excessive focus on the short term and an underestimation of the longer-term consequences of policy choices."
Noting the jobless rate "is expected to remain elevated … for some time," Plosser continued, "it is not at all clear that monetary policy can" make an impact. "In other words, the slow pace of the recovery should not be taken as evidence that the stance of monetary policy is inappropriate or that ever more aggressive accommodation can speed up that pace."
Fed asset purchases "are unlikely" to significantly lower interest rates and "some studies suggest that the effect will be quite small and transitory."
"I share this skepticism," Plosser said, "and so do not believe that attempts to lower interest rates by a few more basis points will spur further growth or higher employment."
Uncertainty about fiscal decisions, he said, are business leaders' greatest concern, and "None think that lowering nominal interest rates by a few basis points will alter their behavior."
Worrying about removing accommodation, Plosser noted, "A rapid tightening of monetary policy may also entail political risks for the Fed. We would likely be selling the longer maturity assets in our portfolio at a loss, meaning that we may be unable to make any remittances to the U.S. Treasury for some years. Yet, if we don't tighten quickly enough, we could find ourselves far behind the curve in restraining inflation."
While it's difficult to quantify these risks, Plosser said, "it is clear that the larger the Fed's portfolio becomes, the greater the risk and the potential costs when it comes time to exit. 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. We know that monetary policy can control inflation, but its ability to manage the unemployment rate is far more dubious. Chasing an elusive goal for unemployment could well risk losing control over inflation. That was the lesson of the Great Inflation during the 1970s."
Additionally, Plosser took issue with purchasing mortgage-backed securities. "In general, central banks should refrain from allocating credit toward one sector or industry. Those types of credit-allocation decisions rightfully belong to the fiscal authorities, not the central bank. Engaging in such actions endangers our independence and the effectiveness of monetary policy."
