WASHINGTON - Philadelphia Federal Reserve Bank President Charles Plosser Friday once again took aim, albeit indirectly, at the manner of the Fed's forward guidance regarding future monetary policy, arguing that such policies will not have the desired effect if the public believes the central bank's commitment is "incomplete."
And in a speech prepared for delivery to the Spring 2012 Research Conference Eltville, Germany, Plosser also warned of the moral hazard when a central bank has no credibility, as it may induce excessive risk-taking.
In remarks that focused on macro models and monetary policy analysis, Plosser did not comment on current economic or monetary conditions.
The Fed's steering body, the Federal Open Market Committee, has said economic conditions will require short-term interest rates remaining exceptionally low until late 2014.
Plosser, who will be a voter on the FOMC in 2014, has always taken issue with the use of a calendar date, cautioning that it backs the Fed into a corner and places the central bank's credibility at risk.
He noted in his speech that zero lower bound policies rely on policymakers "guiding" expectations of when an initial interest rate increase will occur in the future.
"If the credibility of this forward guidance is questioned, evaluation of the zero lower bound policy has to account for the public's beliefs that commitment to this policy is incomplete," he said.
"I have found that policymakers like to presume that their policy actions are completely credible and then engage in decisions accordingly. Yet if that presumption is wrong, those policies will not have the desired or predicted outcomes," Plosser said.
It is also important to consider moral hazard, which is not solely limited to a central bank's role as the lender-of-last-resort but also becomes an issue when monetary policy uses discretion to deviate from its policy rule.
"If the central bank has credibility that it will return to the rule once it has deviated, this may not be much of a problem. On the other hand, a central bank with less credibility, or no credibility, may run the risk of inducing excessive risk-taking," Plosser said.
He cited the "so-called 'Greenspan put,'" named for former Fed chair Alan Greenspan, in which the markets perceived that when asset prices fell, the Fed would respond by reducing interest rates.
And to those who rely on models and economic rules to predict what actions the Fed and other central banks will take next, Plosser warned that monetary policy actions "have become increasingly discretionary."
"The financial crisis and associated policy responses have left many central banks operating with their policy rate near the zero lower bound; this means that they are no longer following a systematic rule, if they ever were," he said.
"Central banks need to ask if discretionary policies can create incentives that fundamentally change the actions and expectations of consumers, workers, firms, and investors," Plosser said.
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