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Fed's Dudley: Assess Job, Inflation Outlook to Decide '13 Treasury Buys

New York Federal Reserve Bank President William Dudley Thursday withheld judgment on whether the Fed should continue buying long-term Treasury securities next year, saying he will be assessing the outlook for employment and inflation.

But up until now Dudley said economic growth has been "insufficient" to make "material" progress reducing "unacceptably high" unemployment.

Meanwhile inflation has been "fully consistent" with the Fed's 2% inflation target and is likely to stay "at or below" that objective, he said in remarks prepared for Pace University in New York City.

Dudley, who is vice chairman of the Federal Reserve's policymaking Federal Open Market Committee, stressed the Fed will strive to quicken the pace of growth and achieve maximum employment "to the greatest extent our tools permit." And he vowed the Fed will "stay the course" --not tighten monetary policy "prematurely" when the economy strengthens.

Monetary stimulus efforts must take place in a context of price stability, Dudley stipulated, but twice he indicated he does not think inflation is or will be an issue.

Dudley also emphasized the importance of reaching a "credible" and "bipartisan" fiscal policy agreement that reduces the federal budget deficit in a way that does not unduly contract the economy.

When the FOMC meets for the final time this year Dec. 11-12, it must decide what to do about the Dec. 31 expiration of the Maturity Extension Program or "Operation Twist," under which the Fed has been buying $45 billion per month in long-term Treasury securities while selling an equivalent amount of short-term Treasuries.

Since September, the Fed has also been buying $40 billion per month of mortgage backed securities, financing them through the creation of new bank reserves. Combining this third round of "quantitative easing" with the second phase of Operation Twist, the Fed has been buying assets at an $85 billion monthly clip.

MNI reported Tuesday there is substantial sentiment for fully replacing the Twist program with outright Treasury purchases rather than allow asset purchases to plunge from $85 billion to $40 billion per month. 

The FOMC, in its Sept. 13 and Oct. 24 policy statements, said, "If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability."

Dudley did not explicitly tip his hand on whether he will support continuing long-term Treasury purchases past Dec. 31, but he made clear he does not see "substantial" labor market improvement.

Even before Hurricane Sandy hit the Northeast and slowed fourth quarter GDP growth by a quarter to half a percentage point, "the pace of U.S. economic growth was disappointing -- averaging only slightly above a 2% annualized growth since the recovery began in mid-2009," he said.

"As a consequence, the national unemployment rate remains unacceptably high, and its decline during the recovery has been grudging," he continued. "In addition, too many people are discouraged from looking for work."

"This has depressed the participation rate and held down the official unemployment rate," Dudley went on. "Moreover, 5 million workers have been unemployed for six months or more."

"While job growth has picked up some recently, its pace has been insufficient to materially change the labor market picture," he added.

Dudley cited "a few bright spots," such as a "bit firmer" pace of consumer spending and improvement in the housing market. But he noted business fixed investment has been falling and "manufacturing activity remains weak."

Meanwhile, on the price stability side of the Fed's dual mandate, he said "overall inflation, as measured by year-over-year changes of the consumer price index, is still around 2% -- significantly lower than last year."

"The signals from underlying inflation pressures, compensation trends, and longer-term inflation expectations are all fully consistent with our longer-run inflation objective of 2%," he said, adding that "price increases are likely to be at or slightly below our 2% longer-run objective over the next few years."

Dudley left little doubt his main focus is on employment at such a time: "Although the economy continues to expand, we must grow faster if we are to put all of our jobless workers and idle businesses back to work."

Answering his own question about what "substantial improvement in the outlook for the labor market" means, Dudley said, he "will be looking at the growth momentum within the overall economy and a range of labor indicators, including the unemployment rate, payrolls, the participation rate, the employment to population ratio and job finding rates."

"Following the framework we set out in September, I will be assessing the employment and inflation outlook in order to determine whether we should continue Treasury purchases into 2013," he said.

While reiterating that "monetary policy is not a panacea for all that ails our economy," Dudley vowed, "We will continue to do our part to push the economy towards maximum sustainable employment in the context of price stability."

Elaborating, he pledged, "the Fed will promote maximum employment and price stability to the greatest extent our tools permit, and we will stay the course."

"When we achieve a stronger recovery in the context of price stability, I'll view it as consistent with our goals and not a reason to pull back on our policies prematurely," he said. "If you're trying to get a car moving that is stuck in the mud, you don't stop pushing the moment the wheels start turning -- you keep pushing until the car is rolling and is clearly free."

Fiscal policy also has an important role to play, Dudley said, at a time when Congress is wrestling with the so-called "fiscal cliff" of tax hikes and spending cuts due to take effect Jan. 1 if nothing is done to avert them.

"Congress and the administration must address the 'fiscal cliff' in a manner that creates a credible framework for long- term fiscal sustainability," he asserted. "It is widely acknowledged that the large fiscal contraction associated with going 'off the cliff' would drive the U.S. economy into recession."

Dudley said "the contractionary impact is likely to be larger than normal when monetary policy is operating at the zero lower bound for interest rates, as is the case today."

He said "fiscal consolidation must be accomplished in a way that avoids derailing the economic recovery."

"The best way to do this is to craft a plan that starts small in terms of its near-term impact, then grows very substantially over time as the economy grows healthier," he added.

Dudley said fiscal uncertainties have helped stymie business spending and damaged confidence in the U.S. economy around the world.

"If a credible bipartisan agreement is reached, it will strengthen global confidence in the U.S. and underscore to the world that our country remains a great place to do business and invest in," he said. "Failure would suggest a degree of political dysfunction that could undermine U.S. economic leadership and could encourage global corporations and investors to invest elsewhere."

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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