Minneapolis Federal Reserve Bank President Narayana Kocherlakota warned Tuesday that reducing Fed asset purchases from current levels would exert a "drag" on an already sluggish economy and said the Fed should consider expanding bond buying and taking other steps to stimulate the economy to achieve "maximum" employment "as rapidly as it can."
Kocherlakota, who will be a voting member of the Fed's policymaking Federal Open Market Committee next year, said the FOMC should also consider reducing the rate of interest it pays on excess reserves (IOER) from the current 25 basis points.
And he repeated his call for lowering the unemployment threshold for considering hikes in the near zero federal funds rate to 5.5% from 6.5% - an idea that got some theoretical support from a Federal Reserve Board research paper released last week.
The FOMC should clearly enunciate a "goal-oriented" monetary policy strategy aimed at slashing joblessness and "do whatever it takes" to achieve that goal, he asserted.
Even to talk about "tapering" asset purchases of longer term Treasury and mortgage-backed securities from $85 billion a month is "puzzling" in the presently "disturbing" labor market environment, Kocherlakota said in remarks prepared for delivery to the St. Paul, Minnesota Chamber of Commerce.
Indeed, he said, mere consideration of reducing "quantitative easing" is creating damaging "doubts and uncertainty" about the FOMC's policy goals. A perception that monetary stimulus has become ineffective is "hurting current employment."
The Labor Department Friday reported a better than expected 204,000 October rise in non-farm payrolls, coupled with a 60,000 upward revision to prior months' jobs. The improvement increased speculation that the FOMC might scale back bond-buying before long.
Kocherlakota strongly dissented from that view. Although the unemployment rate has fallen from 10% in October 2009 to 7.3% last month, he said it remains "unusually high" relative to both the past and to long-term forecasts.
The drop "overstates the improvement in the U.S. labor market," he said. "Most of the declines ... have occurred because the fraction of people who are choosing to look for work has fallen."
Calling the labor market "far from healthy," Kocherlakota said its "painfully slow" improvement has resulted in "considerable hardship" and "a significant waste of resources."
Meanwhile, inflation running far below the FOMC's 2% target leaves policymakers with "a lot of room to provide much needed stimulus to the labor market."
On Oct. 30, for the second straight meeting, the FOMC delayed "tapering," saying it would "await more evidence" of sustained progress on economic growth and job creation.
Nevertheless, Kocherlakota lamented, "there has been an ongoing public conversation about the possibility that the FOMC might reduce its current flow of long-term asset purchases over the next year."
"The timing of this conversation seems puzzling," he said, because "reducing the flow of purchases in the near term would be a drag on the already slow rate of progress of the economy toward the Committee's goals."
In addition, he argued, the conversation itself is damaging.
The FOMC reiterated on Oct. 30 that the pace of asset purchases will depend on "its assessment of the likely efficacy and costs of such purchases."
But Kocherlakota complained "the recent public conversation about reducing the flow of asset purchases typically places little or no emphasis on these costs and efficacy considerations."
"As a result, the dialogue risks creating the perception that the Committee is not following a goal-oriented approach to monetary policy," he said. "Such a perception can create doubts and uncertainty about the criteria underlying Committee decisions."
He cited recent volatility in the bond market volatility as evidence of these "doubts and uncertainty."
The FOMC "could reduce this volatility by greatly enhancing its communication on the role of cost and efficacy considerations in its deliberations about the evolution of asset purchases." Far from reducing asset purchases, Kocherlakota said "doing whatever it takes" to maximize employment "will mean keeping a historically unusual amount of monetary stimulus in place - and possibly providing more stimulus."
That easy, or easier, monetary policy stance should be maintained, according to Kocherlakota, even as:
- "Interest rates remain near historic lows.
- "Economic growth rises above historical averages.
- "Per capita employment begins to rise appreciably.
- "Asset prices rise to unusually high levels, leading to concerns about "bubbles."
- "The medium-term inflation outlook rises temporarily above 2 percent."
Aside from sustaining, if not increasing, asset purchases and lowering the unemployment threshold for raising the funds rate to 5.5%, Kocherlakota suggested the FOMC could also provide more monetary stimulus "by lowering the interest rate being paid to banks on their excess reserves."
Just as former Fed Chair Paul Volcker faced "a severe test" in confronting double-digit inflation in the late 1970s, Kocherlakota said the Fed now faces "a severe test" in fighting high unemployment.
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