WASHINGTON — Given the high level of uncertainty associated with the Federal Reserve's use of asset purchases to spur faster economic growth, some "moderation" of the central bank's use of unconventional policies may be optimal, San Francisco Federal Reserve Bank President John Williams argues.
In a research paper released Tuesday evening, which he will present at a conference in Vancouver, Canada, later this week, Williams noted that senior Federal Reserve officials "are unsure of the future course of the economy and uncertain about the effects of their policy actions.
"Uncertainty about the effects of policies is especially acute in the case of unconventional policy instruments such as using the Fed's balance sheet to influence financial and economic conditions," he added.
"Indeed, once one recognizes uncertainty, some moderation in monetary policy may well be optimal," Williams declared.
The Fed is currently buying $85 billion a month in U.S. Treasury and mortgage bonds, and has vowed to continue doing so until it sees "substantial improvement" labor market conditions.
In recent weeks, expectations that the Fed will begin to taper it asset purchases as soon as September on the back of strong jobs numbers has roiled markets and sparked capital outflows from emerging markets.
"Although there is compelling evidence that the Fed's balance sheet policies have reduced long-term interest rates, considerable uncertainty remains regarding their effects on broader financial conditions, economic activity, and inflation," Williams said.
The target federal funds rate has been kept close to zero since December 2008, forcing the Fed's policymaking Federal Open Market Committee to resort to asset purchases to support the recovery and boost job creation.
However, underlining the eagerness with which Fed officials look forward to the day when conventional short term interest rate policy retakes the stage as the Fed's main tool, Williams stressed that, "In the context of multiple policy instruments, the optimal strategy is to rely on the instrument associated with the least uncertainty and use alternative, more uncertain instruments only when the least uncertain instrument is employed to its fullest extent possible."
"Given the large estimated degree of uncertainty around unconventional policies, it is still the case that uncertainty calls for significant attenuation in the use of these policies," he reiterated.
Williams cited the potential costs that many commentators — some of them Fed officials — have associated with the bond-buying program, such as contributing to the risk of financial instability or unmooring inflation expectations.
In addition, as referenced earlier, "there is also the worry that changes in about unconventional policies is that changes in these policies may be disruptive and engender unmodeled costs," he said.
Perhaps with the market volatility in mind, Williams said "one implication of this concern for deploying unconventional policy is clear. It argues for gradualism in shifts in the stance of policy, both as the policies are increased and are reduced."
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