SAN FRANCISCO — San Francisco Federal Reserve Bank President John Williams said Wednesday night the Fed should fully replace the "Operation Twist" Treasury security purchases which are due to expire in December by expanding its "QE3" asset purchase program.

That would mean that the Fed would continue to buy a total of $85 billion per month of bonds — $40 billion of mortgage backed securities plus $45 billion of long-term Treasury securities, all financed by the creation of new bank reserves.

Although he expects the economy to improve next year, he said there is too much uncertainty and too many downside risks for the Fed to allow its total asset purchases to shrink with the expiration of the Maturity Extension Program ("Operation Twist") under which the Fed finances long-term securities purchases through sales of short-term securities.

Williams, a voting member of the Fed's policymaking Federal Open Market Committee, said he is still "struggling" with whether or not to replace the FOMC's current way of providing "forward guidance" on the path of the federal funds rate.

The FOMC since September has said it expects to keep the funds rate near zero through at least mid-2015. Some, including Fed Vice Chairman Janet Yellen, have spoken in favor of replacing the calendar date with some numerical threshold for changing the funds rate.

Williams said he is not yet convinced that a threshold, such as Chicago Fed President Charles Evans proposed for keeping the funds rate at zero so long as unemployment is above 7% and inflation is below 3%, would be better than a calendar date.

Meeting with reporters following a speech at the University of San Francisco, MNI asked Williams whether he thinks the FOMC should replace the Operation Twist Treasury purchases dollar for dollar upon their expiration Dec. 31. He answered strongly in the affirmative.

"My view is based on the expectation that we won't see substantial improvement in the labor market" for awhile, Williams said, adding that therefore "my view is that we should continue with purchases of long-term Treasuries after December into next year."

Williams said he favors "just purely buying long-term Treasuries at the rate we're buying."

Asked to clarify, Williams said he favors buying MBS and Treasuries "at the same rate we're doing now" -- $85 billion per month.

As for what kind of labor market indicators he would like to see to conclude that there has been "substantial" labor market improvement -- the FOMC's standard for discontinuing QE3 -- Williams said he'd be looking at an array of indicators. But he said that the 170,000 per month average non-farm payroll gains of the past three months would not be sufficient in his views.

"I would definitely think of it as being above 200,000," he said.

He said he wants to see "pretty clear signs of improvement in the labor market ... . I"m looking for a pretty coherent" picture" of "everything on a good pace of improvement."

Yellen said Tuesday she is "strongly supportive" of the kind of numerical thresholds that Evans and others have proposed. But Williams, who was Yellen's top advisor when she was president of the San Francisco Fed, said he is still "wrestling" with whether the FOMC should take a "quantitative" approach to communicating about how long it will hold the funds rate at zero.

He said that announcing a 7% unemployment threshold would put "a bright light" on that number and lead people to believe the Fed is targeting that rate of unemployment. In reality, he said, the Fed bases rate decisions on other factors, not just the unemployment rate.

"If you're going to go quantitative you really have to be careful about explaining the qualifiers," he said.

"The status quo is that we have a date, and the question is do you add something to that qualitatively," he said.

"The date has been a very effective way to convey a simple message," he went on. "It's a pretty powerful clear signal of its own even if it doesn't satisfy all the" critics.

"To me (the question is) can we come up with quantitative thresholds that are better than what we do today, recognizing that we do today is imperfect?"

Earlier, in response to audience questions, Williams said he sees no signs that unconventional monetary policy has reached a point of "diminishing returns" and is now "pushing on a string."

Rather, he said, he has become "more optimistic" about the efficacy of Fed asset purchases. Noting improvements in interest-sensitive sectors like autos and housing, he said the Fed's efforts to push down interest rates are more like "pushing on a car" and making it move faster.

Using a medical analogy, Williams said he and most of his Fed colleagues recognize the danger of taking away the "medicine" too soon before the economy's ills are completely cured.

Williams also took issue with an audience member's suggestion that the Fed is "printing money." He acknowledged that the Fed has dramatically increased bank reserves to roughly $1.5 trillion, but he said this has not been accompanied by a commensurate increase in the amount of money circulating in the economy.

And he said the purpose of the Fed's three rounds of quantitative easing has not been to expand reserves but to buy assets and thereby affect interest rates and yield spreads.


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