Now is the time to bring monetary policy back to normal and for the Federal Reserve, and other central banks to back away from the "interventionist" role they have taken since the crisis, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Thursday.
"We must back away from increasing the degree of policy accommodation in a manner commensurate with an improving economy," Plosser told an audience in England, according to prepared text of his remarks. "Reducing the pace of asset purchases in measured steps is moving in the right direction, but the pace may leave us well behind the curve if the economy continues to play out according to the FOMC forecasts."
When the asset purchases have concluded, he noted, "monetary policy will still be highly accommodative." The Fed will need to remove the accommodation "normalize policy" without cutting off economic growth or causing a spike in inflation, to "avoid sowing the seeds of another financial crisis," Plosser said.
Regarding the Fed becoming "much more interventionist," Plosser said, "I do not think this is a particularly healthy state of affairs for the central banks or our economies. The crisis in the U.S. has long passed. With a growing economy and the Fed's long-term asset purchases coming to an end, now is the time to contemplate restoring some semblance of normalcy to monetary policy."
In Plosser's opinion, monetary policy should "work behind the scenes in limited and systematic ways to promote long-term growth and price stability." Central banks since the crisis "have become highly interventionist in their efforts to manipulate asset prices and financial markets in general as they attempt to fine-tune economic outcomes."
Despite the crisis' end, this approach has remained, he noted. "While the motivations may be noble, we have created an environment where 'it is all about the Fed.' Market participants focus entirely too much on how the central bank may tweak its policy, and central bankers have become too sensitive and desirous of managing prices in the financial world. I do not see this as a healthy symbiotic relationship for the long term."
By relying on the Fed instead of "economic fundamentals, our capital markets will cease to deliver the economic benefits they are capable of providing. And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus, instead, on the next actions of the central bank."
Plosser said "the U.S. economy is on firmer footing today than it has been in several years. This is a cause for some optimism for continued progress in 2014."
Recent weakness in economic reports, he said, were weather-related and therefore shouldn't be taken as too significant. "As a monetary policymaker, I prefer to take a longer view rather than let our decisions be whipsawed by the most recent statistics, which are often noisy and subject to revision. Because monetary policy tends to work with a lag, we must keep our attention focused on the intermediate- to longer-term underlying trends if we are to make wise decisions."
Although GDP has been "far from the robust growth that many would like to see," it has shown "steady progress and an improving economy." Plosser sees 3% GDP growth this year and unemployment of 6.2% at year-end, "and, if anything, that may prove too pessimistic. Given the recent trends, an unemployment rate below 6% is certainly plausible."
While the FOMC has a plan for gradual reduction in asset purchases, with an eye toward ending the program this year, Plosser noted, "If the economy continues to improve, we could find ourselves still trying to increase accommodation in an environment in which history suggests that policy should perhaps be moving in the opposite direction."
With the unemployment rate at 6.6%, and despite the FOMC's repeated vows not to raise rates as soon as it hits 6.5%, Plosser said the situation poses "a communications challenge. In particular, we have not described how policy will be conducted after the unemployment rate falls below 6.5%."
