WASHINGTON — Cleveland Federal Reserve Bank President Sandra Pianalto Friday said the central bank could aim to trim the size of its swollen balance sheet before the end of the year if the outlook for the economy continues to improve as she expects it will, citing her concern about the risks posed by the central bank's $84 billion a month asset purchase program.
In prepared remarks at Florida Gulf Coast University, Pianalto — who does not hold a voting position on the policymaking Federal Open Market Committee this year — indicated her dissatisfaction with the current pace of growth, saying it is still not fast enough to dig the country out of the jobs crisis that it remains mired in.
Pianalto is considered one of the middle-of-the-road senior Fed officials, who has constantly advocated that the Fed remain cognizant of the risks posed by its aggressive bond-buying as it seeks to spark faster growth and greater job creation.
Pianalto cited four issues as examples of some of the risks that come with the Fed's actions: credit risk — investors reaching for yield; interest rate risk — potential losses from holding too many fixed rate assets when interest rates rise; risk of adverse market functioning — the market being distorted by the Fed's outsized presence in bond markets; and inflation risk — the Fed's ability to effectively respond to inflationary pressures complicated by its massive portfolio.
"To minimize some of these risks, we could aim for a smaller sized balance sheet than would otherwise occur if we were to maintain the current pace of asset purchases through the end of this year, as some financial market participants are expecting," she said. "This course of action would be all the more attractive if the economic outlook continues to improve, as I expect it will."
Aside from the potential costs, Pianalto warned that "over time, the benefits of our asset purchases may be diminishing." She gave the example that given the current low level of interest rates, future asset purchases might not ease financial conditions by as much as they have in the past.
Also, "it is also possible that easier financial conditions, to the extent they do occur, may not provide the same boost to the economy as they have in the past," she cautioned.
At some point, Pianalto predicted, further actions by the Fed might cause more harm than good underlining the need for the central bank to tread lightly in its decision-making.
"We should be sure that when the time comes, we can exit without adversely impacting markets, without allowing an undesirable increase in inflation, and without risking the progress that has already occurred in our economic recovery," she said.
Still, the Fed's unconventional actions during the recession and after have gotten the economy to a point where it is growing today, "albeit at a moderate pace," she said. Pianalto cited examples such as lower mortgage rates that have contributed to the improvement in the housing market, and the jump in commercial paper outstanding — indicated an increased desire among companies for this low-cost alternative to bank loans for financing.
Despite all this, however, Pianalto expects the U.S. economy to grow by little more than 2.5% this year and about 3% in 2014. While a 2.5% growth rate might be satisfactory in normal times, "it's not strong enough to dig us out of the deep unemployment hole we're in — at least, not for the next several years," she said.
She forecasts the unemployment rate to fall to 7.5% in 2013 and then further in 2014 to end the year close to 7%. "Which means we will still fall short of full employment for several years to come," Pianalto said, adding "Faster economic growth is necessary for our economy to return to full employment more quickly."
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