NEW YORK – With the economy still sluggish, the Federal Open Market Committee needed to take action because the costs of extended periods of high unemployment or disinflation “could be quite high and potentially very damaging,” Federal Reserve Bank of Boston President and Chief Executive Officer Eric S. Rosengren said today.
“An argument against further monetary easing could be made if one thought the economy was about to take off,” he told the Greater Providence Chamber of Commerce, according to prepared text of a speech, which was released by the Fed. But, he added, recent data suggest the economy will remain sluggish.
GDP grew by just 2% in the third quarter, while third-quarter final sales were “quite anemic,” and have fallen for the past four quarters. Sales are a better measure of demand, he noted.
The belief is that it will take four to five years of above normal growth to bring down the unemployment rate to a level consistent with “full
employment.”
“With both employment and inflation falling short of the long-run expectations that reflect the Fed’s mandate, one would expect additional accommodative monetary policy,” Rosengren said. “However, with the federal funds rate close to zero, the Fed’s usual policy tool could not be utilized.”
Rosengren said the “asset-purchase policy announced at the November FOMC meeting was in my view strongly consistent with our dual mandate from Congress – in other words, the pursuit of maximum sustainable employment and stable prices.”
To critics, who felt the Fed should have done nothing, Rosengren said, “Not changing policy risked further disinflation, a rise in the real cost of funds tantamount to monetary tightening, and risks of continued and possibly worsening pain in labor markets.”
Also, had the federal funds rate not been close to zero, “the arguments for reducing it – that is, for easing in monetary policy – would be quite strong.”
Rosengren said large-scale asset purchases are “closer to traditional monetary policy than many commentators assume.” He explained, the Fed moves “in other markets than the federal funds market.” And, he noted these are not “bailouts” or stimulus spending and there is no debt burden on future generations.
“Instead of relying on the indirect effects of targeting a lower funds rate, we are opting to more directly affect the interest rates that have the greatest connection to real spending; by buying Treasury bonds and creating additional bank reserves,” he said. “Since there are already substantial reserves in the system, the primary expected effect is lowering the long rate by purchasing a significant amount of longer-term Treasury bonds. Like conventional policy, one would expect that mortgage and corporate rates will fall, and exchange rates will be impacted, providing additional stimulus to the economy. That is in fact what has already happened.”
Many things affect rates, but longer term rates have been trending down. “I am certain that our purchases over time will contribute to lower rates than we would otherwise be seeing,” Rosengren said.
In short this action, like more standard reductions in the federal funds rate, has broadly
speaking had the expected short-run effect and should be helpful going forward.
Several risks are involved with the asset-purchasing plan. First, the Fed is “taking on the risk that their value will fall as interest rates rise.”
A second risk results from the size of the Treasury market, which makes large purchases necessary to move rates, so “this policy requires the Federal Reserve to expand its balance sheet much more than would a traditional monetary easing. Large expansions of the balance sheet can complicate exit strategy, when that becomes appropriate,” Rosengren explained.
Another risk is uncertainty since “these measures have not been conducted in the United States, at least at the current scale,” so “the possibility of unintended consequences higher than with more typical monetary policy actions.”
Also, the risk of raising inflation too high exists.
“Finally, some have argued that the Fed is embarking on a policy of monetizing the federal debt. I would counter that this is a temporary monetary policy action taken to return inflation and unemployment somewhat more quickly than otherwise to levels consistent with our mandate,” Rosengren said. “It is a policy designed to help reduce longer term rates over a fixed period of time, not at all a policy to finance government debt indefinitely. I have noted in previous talks that it is important to provide short-term stimulus, given the current economic situation, but that long-run budget projections are not sustainable and will need to be addressed. It is important to note that large scale asset purchases do not necessarily need to use Treasury-security purchases to stimulate the economy; indeed in our first round we did so with mortgage-backed securities.”
Rosengren noted that since the Fed is “aware of these risks. I fully expect that we will be able to manage them.”
