The Federal Open Market Committee's decision to taper bond purchases "pleased" Federal Reserve Bank of Dallas President and CEO Richard W. Fisher, who said Tuesday he would have preferred a larger taper and he will push to end asset purchases as quickly as possible.
"I was pleased with the decision to finally begin tapering our bond purchases, though I would have preferred to pull back our purchases by double the announced amount," Fisher told the National Association of Corporate Directors, according to prepared text of his remarks, released by the Fed. "But the important thing for me is that the committee began the process of slowing down the ballooning of our balance sheet, which at year-end exceeded $4 trillion. And we began-and I use that word deliberately, for we have more to do on this front-to clarify our intentions for managing the overnight money rate."
With an expanding economy, improving housing market and falling unemployment, Fisher said, "the odds favor continued economic progress." However, "continuing large-scale asset purchases risks placing us in an untenable position, both from the standpoint of unreasonably inflating the stock, bond and other tradable asset markets and from the perspective of complicating the future conduct of monetary policy."
He called the chances of "a clean exit narrow," and suggested, "As soon as feasible, we should change tack. We should stop digging. I plan to cast my votes at FOMC meetings accordingly."
Even if the soaring stock market hit a correction, Fisher said, "I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date."
While he said he believes a $2 trillion balance sheet would provide enough of a wealth effect to spur the economy, he said, "The FOMC is a committee, however, and the majority of my colleagues have disagreed with me on this point. We have since doubled our balance sheet to $4 trillion. This has resulted not only in saltatory housing, bond and stock markets, but a real economy that is on the mend, with cyclical unemployment declining and inflation thus far held at bay."
However, the last $2 trillion added to the balance sheet were longer maturity securities. "To be sure, Treasury and MBS markets are liquid markets. But the old market operator in me is conscious that we hold nearly 40 percent of outstanding eligible MBS and of Treasuries with more than five years to maturity. Selling that concentrated an amount of even the most presumably liquid assets would be a heck of lot more complicated than accumulating it."
While not an issue at the moment, when the economic growth "the massive amount of money sitting on the sidelines will be activated; the 'velocity' of money will accelerate. If it does so too quickly, we might create inflation or financial market instability or both," Fisher said.
With 65% of the monetary base in excess reserves, Fisher said, "We are in uncharted territory.
"To prevent excess reserves from fueling a too-rapid expansion of bank lending in an expanding economy, the Fed will need to either drain reserves on a large scale by selling longer-term assets at a loss or provide inducements to banks to keep reserves idle, by offering interest on excess reserves at a rate competitive with what banks might earn on loans to businesses and consumers. Or we might employ more widely new techniques we are currently testing, such as 'reverse repos,' complex transactions in which we, in effect, borrow cash overnight from market operators while posting securities as collateral."
These methods may lead to "intense scrutiny and criticism" of the Fed. "Of greatest concern to me is that the risk of scrutiny and criticism might hinder policymakers from acting quickly enough to remove or dampen the dry inflationary tinder that is inherent in the massive, but currently fallow, monetary base."
The "exit is somewhat daunting," he said, "I have great faith in the integrity and brainpower of my fellow policymakers. I am confident that the 19 earnest women and men that make up the FOMC will do their level best under Chairwoman Janet Yellen's leadership to accomplish a smooth exit that keeps prices stable and the economy in a job-creating mode. But my confidence will be bolstered if my colleagues adopt the First Law of Holes espoused in the late '70s by then-British Chancellor of the Exchequer Denis Healey: 'If you find yourself in a hole, stop digging.'"
