Charles Plosser: Fed Should Taper Asset Purchases, End Them by Year End

The $85 billion of longer-term assets the Fed is buying each month provides more potential risk than benefits and the Fed should start tapering these buys, with the intention of stopping completely before year end, Federal Reserve Bank of Philadelphia President Charles Plosser said Wednesday.

Uncertainty exists as to "whether the Fed's growing presence in the market for mortgage-backed securities will distort the functioning of this market in the longer run," Plosser told the Economic Development Finance Corporation of Lancaster County, according to prepared text of his remarks released by the Fed. "But with the large volume of purchases the Fed is making, this possibility needs to remain on our radar screen."

Additionally the accommodative monetary policy could "complicate the Fed's exit from the nontraditional policies and undermine its ability to achieve long-run price stability."

With the Fed's holding $1.7 trillion of reserves, once the recovery picks up momentum and long-term interest rates rise, banks will start. "Loan growth and economic activity will pick up, and the Fed will need to withdraw accommodation - and it may have to do so quickly - to restrain inflationary pressures."

Also, he noted, forward guidance is only effective as a policy tool, when the Fed shows "commitment to longer-run price stability." If the Fed deliberately lets inflation "deviate from the central bank's longer-term goal for too long," even slightly, "inflation expectations could become unanchored," washing away "whatever credibility the central bank had previously accrued." While trying "reestablish their reputation, inflation, employment, and output would all suffer."

With consumers concerned about the future, they are saving more and spending less. Plosser said, "They are behaving wisely and in a perfectly rational and prudent way in the face of the reduction in wealth."

But, he warned, "Attempts to increase economic 'stimulus' may not help speed up the process and may actually prolong it."

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