NEW YORK – Further monetary policy accommodation was not clearly needed when the Fed pulled its Twist, and the action taken “will do little to improve the near-term prospects for economic growth or employment, but they do pose some real risks,” Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Wednesday.
Plosser said his “no” vote was partly based on higher inflation combined with lower unemployment seen since QE2 was launched. “Policy actions are not free and should be evaluated based on the costs and benefits,” he told a realtors conference, according to prepared text of remarks released by the Fed.
The move, he estimated, would only cut about 20 basis points from long-term rates, with “considerably less” pass-through to consumers and businesses that are looking to borrow funds. “Thus,” Plosser said, “I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad.”
The policies, Plosser said, could spur a continued steady rise in inflation, “creating an environment of stagflation. … “It is an outcome we must carefully guard against.”
Also important is maintaining the Fed’s credibility, which help it “maintain price stability and promote economic growth.” Plosser said, “In my view, the actions taken in August and September risk undermining the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not. We should not take actions simply because we can. To address our economic ills we must apply the appropriate remedies. A doctor who misdiagnoses a disease and prescribes the wrong medicine can make the patient worse. The ills we currently face are not readily resolved through ever more accommodative monetary policy. If we act as if the Fed has the ability to solve all our economic problems, our credibility will be undermined. The loss of that credibility and the loss of the public’s confidence could be costly to the economy because it will make it much harder for the Fed to implement effective monetary policy in the future.”
Another problem Plosser foresees is Operation Twist will make exiting “extraordinary accommodation more complicated. Since we will have more long-term Treasury securities and mortgage-backed securities in our portfolio, the time it will take to unwind and get back to our stated goal of returning to an all-Treasuries portfolio and shrinking our balance sheet may need to be extended and may put at risk our ability to control inflation over the medium term.”
Despite his opposition to the past two Fed moves, there are situations that Plosser said would require Fed action. “Should the developments in the euro area lead to significant financial market disruptions, the Fed would need to respond in its role of lender of last resort to support financial stability and the payments system. Or if deflationary fears were to become a real threat again and we saw signs that the economy was moving to a sustained disinflation with declining inflation rates and inflation expectations, then we would need to consider further action to stabilize inflation expectations.”
As for the economy in general, Plosser said it hasn’t “lived up to expectations this year,” mostly as a result of transitory factors, but while they will wane, “the cumulative effect has served to feed uncertainty and inhibit growth.”
Plosser expects GDP growth to be less than 2% this year and “around 3%” next year, but sees no double-dip recession. While the Bank’s Business Outlook Survey of manufacturers, suggests condition are weakening, Plosser explained that the August survey was conducted right after Standard & Poor’s downgraded “U.S. debt, and the September survey occurred just days after the hurricanes and the severe flooding in New Jersey and Pennsylvania.” And, while current conditions were viewed as negative, measures of future activity were positive, improving from August to September.
Labor market weakness remains “a serious challenge,” he said, and the unemployment rate, will probably change little until year end, and then gradually dip to a range of 8% to 8.5% by the end on next year.
Plosser repeated his goal of implementing an explicit numerical inflation goal, calling now “an opportune time to do so.”
“Having such an objective in place would prove particularly useful in the current environment in which the Fed is providing monetary stimulus using new tools that are not as familiar to the public and when some may view the fiscal situation as threatening the independence of the Federal Reserve and its ability to maintain price stability. And it will help in the future by keeping inflation expectations well anchored during the eventual exit from these extraordinarily accommodative measures,” he said.
