Fed's Rosengren: Bond Buying Has Fiscal Benefits as Well as Costs

While the Federal Reserve's asset purchase program does pose potential problems when it comes time for the Fed to tighten monetary policy, the benefits of the Fed's so-called "quantitative easing" may outweigh the costs and risks, Boston Federal Reserve Bank President Eric Rosengren said Friday.

Without its large-scale asset purchases, the Fed would be much further away from its "dual mandate" goals on unemployment and inflation, Rosengren said. And that, in turn would mean even bigger budget deficits for the federal government.

Rosengren said bond yields can rise because of deficit spending, but also because of other reasons in prepared remarks at a Monetary Policy Forum sponsored by the University of Chicago's Booth School of Business School.

He was responding to a lengthy research paper by former Fed Governor Frederic Mishkin and other economists. Their report warned that, the more the Fed grows its securities portfolio, the more vulnerable it becomes to capital losses when interest rates rise.

As rates rise, the Fed will have to pay banks more on their reserves, meaning less annual remittances to the U.S. Treasury and even greater debt problems for the U.S. government, Mishkin and his fellow economists warn.

If the U.S. debt to GDP ratio continues to climb from 80%, the nation could reach a "fiscal tipping point," at which it would become very difficult for the Fed to stimulate the economy, the report warned. Indeed, the Fed could find itself forced to "monetize" the federal debt at the cost of rising inflation.

Rosengren, who voted to continue $85 billion per month in securities purchases at the Jan. 30 FOMC meeting, acknowledged such dangers, as did the FOMC's latest policy statement. But he emphasized some offsetting positives.

"Hitting fiscal tipping points can have dire consequences for all citizens -- and predicting when such a tipping point will be hit is difficult," he said. "As a result, fiscal and monetary policymakers need to be mindful of the potential of their actions to impact tipping points."

However, he went on, the Fed's large-scale asset purchases "improves the broader fiscal outlook by lowering interest rates and providing more economic growth."

"In addition, it returns the economy to full employment and an inflation rate at the 2 percent target more quickly than would have occurred in the absence of such actions," Rosengren continued. "We do well to also consider these benefits, and the costs of inaction, when evaluating policy."

Elaborating, Rosengren estimated that $750 billion of bond purchases lowers long-term rates by 20 to 25 basis points, "relative to not making the additional purchases."

And "the impact of this large a reduction in long-term rates is a cumulative gain in real GDP, relative to the base, of 1.6% or $260 billion," he continued. "In our model such a purchase also results in a decline in the unemployment rate of 0.25% or 400,000 jobs."

What's more, Rosengren said assessments of the fiscal impact of Fed bond buying need to look beyond the amount of remittances to the Treasury, beginning with the reduced Treasury borrowing costs caused by Fed bond purchases.

"The second fiscal impact would be from faster economic growth," he said. "Faster economic growth produces more tax revenue and, by reducing unemployment, reduces government entitlement expenditures on programs such as unemployment insurance. Thus, LSAPs actually produce a much more positive fiscal impact than the authors suggest."

And that's not all. Rosengren said the evaluation of the benefits of QE also "needs to include the contributions of LSAPs to achieving the goals of the dual mandate for U.S. monetary policy."

Referring to unemployment of 7.9% and PCE inflation of 1.3%, he said, "Had we not undertaken LSAP policies, we would be even further away from achieving each element of our dual mandate, with an unemployment rate higher and an inflation rate lower than we currently have (assuming we have been successful in improving the economy)."

Rosengren also cited the decline in loan rates on mortgages and autos and the resulting growth in those sectors owing to Fed easing measures. And he attributed declines in unemployment to Fed bond buying and zero interest rates.

"Extended periods of unemployment may have long-run costs that have both fiscal and broader economic impacts," he said. "If an extended period of high unemployment causes more workers to drop out of the labor force and places many new workers on a permanently lower income growth path ... then failing toundertake LSAPs can have much broader impacts on fiscal and economic policies."

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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