It is "appropriate" for the Fed to cut down on its asset purchases, according to Federal Reserve Bank of Kansas City President and Chief Executive Officer Esther L. George.
"I support slowing the pace of asset purchases as an appropriate next step for monetary policy," George was going to tell a gathering in Santa Fe, N.M., according to prepared text of a speech cancelled due to illness.
Slowing the purchases "would not constitute an outright tightening of monetary policy, but rather, it would slow policy easing," according to the text. "History suggests that waiting too long to acknowledge the economy's progress and prepare markets for more-normal policy settings carries no less risk than tightening too soon."
Using a driving analogy, she deemed it comparable to "applying less pressure to the gas pedal, rather than stepping on the brake."
Since the financial crisis, she noted, "the FOMC has engaged in an experiment of aggressive monetary policy easing. For the most part, these policy actions have few precedents, and therefore, no simple formula exists to direct policymakers on how to eventually return monetary policy to more-normal settings. Because of this, considerable judgment that is informed by history and experience will be important for guiding future policy choices."
Housing, labor markets and the general economy have improved, yet growth "may be tempered …. by fiscal issues associated with mandated federal government spending cuts and uncertainty about future tax policy and government spending."
Despite these headwinds, George expects growth near 2% in 2013 and low inflation. In 2014, growth should be about 3%, and unemployment should drop further.
"With the economy improving and with monetary policy having been extraordinarily accommodative for nearly half a decade, the world, it seems, is holding its breath as it waits to learn when the FOMC might adjust its current policy settings," according to the text. "This anxiety follows in part from the fact that a number of global economies have come to depend on central banks to provide unprecedented amounts of money to engineer growth and influence asset values, fearing otherwise that deflation would take hold."
The downside of near-zero short-term interest rates is that some parts of "the economy are becoming increasingly dependent on near-zero short-term interest rates and quantitative easing policies. … Investors are borrowing at very low rates of interest to purchase riskier financial assets. Presumably, some investors are pursuing this strategy because they anticipate that loans will continue to be available at very low rates of interest, which will allow them to ride out any market volatility."
Monetary policy alone cannot by itself lower the unemployment rate, George said in the prepared remarks. "That will take additional time. In maintaining its present course, the FOMC must consider other possible unintended consequences. For example, will continuing with current policy and the creation of even greater excess reserves in the banking system result in more lending and economic growth or merely invite asset misallocation? Are we creating a path to stable long-term growth or fostering uncertainty about the impact to the economy when the Federal Reserve must unwind its balance sheet?"
