Philadelphia Federal Reserve Bank President Charles Plosser renewed his warning Tuesday that the Fed's super-low interest rate policies risk higher inflation without doing much to boost the economy.
Plosser said the Fed should raise the federal funds rate and, by implication, halt asset purchases, sooner than policymakers now envision.
The Fed's zero short-term interest rate stance and its "quantitative easing" to hold down long-term rates cannot achieve their growth and employment objectives because they go against Americans' current proclivity to increase savings.
The speech prepared for delivery to an annual economic seminar in Rochester, N.Y., where he was a long-time professor at the city's eponymous university, was similar to the one he delivered Friday in Somerset, N.J.
Plosser, who is not voting on the Fed's policymaking Federal Open Market Committee this year, projected somewhat faster growth than most of his colleagues expect, "about 3% in 2013 and 2014." At that above-trend pace, he said the unemployment rate should fall "near 7%" by year's end.
Although he did not repeat it in his prepared remarks, Plosser recently said such a further decline in joblessness would constitute sufficiently "substantial" improvement in labor market conditions to halt Fed bond buying - something he feels never should have begun.
The Fed should not try to accelerate the pace of growth or job creation, he argued.
"The conventional view is that by lowering interest rates, monetary policy lowers the price of consuming today relative to consuming in the future, thereby encouraging households to reduce savings and bring consumption forward," he said.
However, "in the current circumstances, consumers have strong incentives to save," he said. "They are trying to restore the health of their balance sheets so they will be able to retire or put their children through college. They are behaving wisely and in a perfectly rational and prudent way in the face of the reduction in wealth."
Plosser said "low interest rates and large budget deficits can frustrate those efforts to save."
In fact, "low interest rates encourage households to save even more because the return on their savings is very small," he said. "And large budget deficits suggest that they are likely to face higher taxes in the future, which also encourages more saving."
So Plosser contended that "efforts to drive real rates more negative or promises to keep rates low for a long time may have frustrated households' efforts to rebuild their balance sheets without stimulating aggregate demand or consumption."
"In my view, until household balance sheets are restored to a level that consumers and households find comfortable, consumption will remain sluggish," he added. "This is likely to take some time, and attempts to increase economic 'stimulus' may not help speed up the process and may actually prolong it.
Fiscal and other uncertainties are also exerting a drag on economic growth which the Fed cannot counteract, Plosser said, noting "monetary policy accommodation that lowers interest rates is unlikely to stimulate firms to hire and invest until a significant amount of the uncertainty has been resolved."
While doing little to spur growth, lax monetary policy heightens inflation risks, he contended.
While he does "not see a risk of higher inflation, or deflation, in the near term" and projected inflation will stay near the Fed's 2% target for awhile, he cautioned that "this expectation is based on my assessment that the appropriate monetary policy is likely to tighten more quickly than the Committee anticipated in its latest statement.
"Thus, I do see some risks to inflation in the medium to longer run, given the current stance and anticipated path of monetary policy."
Plosser warned that, "with the very accommodative stance of monetary policy in place for more than four years now, we must guard against the medium- and longer-term risks of inflation."
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