NEW YORK – The nation needs to be aware of the possibility that inflation may creep up while monetary policy remains “very accommodative,” Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Wednesday.
In addition to weaker-than-forecast growth in 2011, overall inflation was 3%, above the 2% Plosser said he expected, mainly from large increases in food and energy prices early in the year. Core inflation was up 2.2%. Plosser said he expects inflation to moderate in the near term.
“As a policymaker, though, I focus less on the near term and more on the medium term. Given the very accommodative monetary policy that has been in place for more than three years, I believe we must continue to monitor inflation measures very carefully,” he told the Main Line Chamber of Commerce, according to prepared text released by the Fed.
“Inflation most often develops gradually, and if monetary policy waits too long to respond, it can be very costly to correct,” Plosser warned. “Measures of slack such as the unemployment rate are often thought to prevent inflation from rising. But that did not turn out to be true in the 1970s. Thus, we need to proceed with caution as to the degree of monetary accommodation we supply to the economy.”
Plosser dissented from FOMC decisions in August and September, saying, “it was not clear to me that further monetary policy accommodation was appropriate. After all, inflation was higher and unemployment was lower relative to the previous year. Moreover, policy actions are never free; they need to be evaluated based on a thorough analysis of costs and benefits. I believed that the benefits of further monetary policy easing were small at best, since, in my view, they would do little to help resolve the challenges we face on the employment front. But the potential costs of this further accommodation could translate into a steady rise in inflation over the medium term, even without much of a drop in the unemployment rate. In my assessment, the potential costs of further accommodation outweighed the potential benefits.”
Also objecting to the Fed’s 18-month extension of the expectation of exceptionally low rates, Plosser said, it was based on “similar reasons.”
“In my view, economic conditions have modestly improved since our December meeting, especially on the employment front, and the downside risk of a double-dip recession that many feared in September when the Committee instituted ‘operation twist’ has substantially abated. Thus, with the economy gradually improving, I saw little justification to further ease monetary policy and felt it risked undermining confidence in the process,” he said.
Plosser added that he opposes “the practice of offering forward policy guidance by saying economic conditions are likely to lead to low rates through some calendar date. Such statements are, in my mind, particularly problematic from a communications perspective. Monetary policy should be contingent on the economic environment and not on the calendar.”
Also, he noted, the policy is misunderstood as a pledge to hold rates until late 2014. “This is clearly incorrect. The FOMC has made no such commitment and the statement indicates as much – if economic conditions change, then so will policy. Yet there continues to be confusion and the confusion stems from our statement. In my view, there are much better ways to communicate information about the future path of policy than the use of calendar dates. Indeed, one of these ways was provided in January when we began providing information on the policy paths that underlie FOMC participants’ forecasts.”
Hailing the expanded Summary of Economic Projections that includes projections for the Fed funds rate, Plosser said, “the expanded SEP will add an important perspective not just of prospective policy at a point in time, but of how the policy projections are influenced as economic conditions change.”
As for the economy, Plosser expects about 3% growth this year and next. Business sentiment, and spending, will improve.
“On the housing front, I expect to see stabilization but not much improvement in 2012,” Plosser said. “We entered the Great Recession over-invested in residential real estate, and we are not likely to see a housing recovery until the surplus inventory of foreclosed and distressed properties declines. Even as the economy rebalances, we should not seek nor should we expect housing and related sectors to return to those pre-recession highs. Those exuberant days were simply not sustainable, and it would be a mistake to retain that standard as our benchmark for recovery.”
Households will continue saving and paying off debt, with “the drag on growth from this rebalancing” gradually lessening.
Labor markets are improving, but “there is a long way to go in restoring a vibrant labor market,” Plosser said.
The sovereign debt crisis in Europe is the biggest risk to the U.S. economy, at the moment, Plosser said, and “regardless of how the European situation plays out, it has already imposed considerable uncertainty on growth prospects for the global economy.”
He continued, “That uncertainty has been compounded by our own nation’s inability to establish a clear plan to put our fiscal policy on a sustainable path. Until the economic environment becomes clearer, firms and consumers are likely to postpone significant spending and hiring decisions – posing a drag on the recovery, even as economic developments in the U.S. continue to improve.”