NEW YORK – The Fed can do more to help the economy, and buying mortgage-backed securities could be a good start, since it would boost the beleaguered housing market, Federal Reserve Bank of New York President William Dudley said Thursday.
Although monetary policy is restrained in its ability to assist the economy since its funds rate target is near zero, so the Fed has “to rely on other, less efficient means, to put further downward pressure on longer term borrowing costs,” and thereby making it “progressively more difficult to induce households with low-debt to bring forward consumption by buying motor vehicles or other consumer durables, and to provide further support for asset prices and household net worth.”
“Despite this, we are not out of ammunition,” he told the United States Military Academy at West Point, according to text released by the Fed.
“We could do more in both directions,” he said. “For instance, we could elaborate on our forward commitment to keep short-term rates low. Indeed, I believe it would be desirable if the committee were able to provide additional guidance as to the economic conditions that the committee would expect to see before raising interest rates.”
Another possibility is buying more longer-term financial assets. “If additional asset purchases were deemed appropriate, it might make sense to do much of this in the mortgage-backed securities market,” Dudley said. “This would have a greater direct impact on the housing market and would be less likely to disrupt market functioning compared with further purchases in the Treasury market.”
But, he noted, there are costs and benefits to further action. “Forward commitment entails some risks to our credibility since it is difficult to capture all the considerations that go into policy judgments in simple and concise language. And balance sheet expansion has potential costs, as well.
“These potential costs stem not only because some may view balance sheet expansion as sowing the seeds of future inflation—an incorrect view in my opinion—but also because balance sheet expansion increases the amount of interest rate risk in the Federal Reserve's portfolio of assets and could, if carried to an extreme, harm private market functioning.”
He said questions about the costs are what drive the “vigorous debate among FOMC participants about whether more monetary policy stimulus should be applied.”
But further stimulus doesn’t worry Dudley. “For my own part, I am deeply unhappy with the current forecast of prolonged high unemployment, and will continue to review whether there is more that we could do that would bring more benefit than cost,” he said.
“Monetary policy must do its part. But there is a strong case for complementary policy actions because such actions can help secure better outcomes than can be achieved through monetary policy alone. If we are to achieve the best possible recovery and build for the future, we will also need ongoing efforts across four broad fronts: financial stability, housing policy, fiscal policy and structural adjustment to foster more sustainable U.S. growth and a more balanced global economy.”
The president and Congress also need to “craft a coherent fiscal policy, that would provide “near-term fiscal support to underpin economic activity and long-term fiscal consolidation to ensure debt sustainability.”
He warned, “Without action in Washington, fiscal policy will turn sharply restrictive in 2012—exerting a direct drag on real GDP growth of more than one percentage point. At the same time, the long-term path under current policy is unsustainable.”
Still, downside risks threaten the forecast, “especially if the stresses in Europe continue to escalate, or if little progress is made on housing, fiscal policy and global rebalancing. In particular, accommodative monetary policy becomes much less effective if the housing market remains in the doldrums.”
