WASHINGTON — San Francisco Federal Reserve Bank President John Williams Monday night offered a bullish assessment of the impact the central bank's unconventional policies are having on the sluggish U.S. economy, citing an uptick in spending and "signs of life" in the housing sector.
In remarks prepared for delivery to the Center for Economics and Public Policy at University of California Irvine, Williams cautioned, however, that the Fed's use of measures such as large-scale asset purchases puts it in unchartered territory, with some of the consequences of its actions still unknown.
Williams is a voter on the Fed's policymaking Federal Open Market Committee this year. The group will have to decide at its Dec. 11-12 meeting if it should continue buying long-term U.S. government securities — to go along with $40 billion a month in mortgage bonds purchases — to support the recovery.
The FOMC has also said it expects to keep short-term interest rates at exceptionally low rates until mid-2015, and Williams said the forward policy guidance "has proven to be effective at lowering expectations of future interest rates."
"Similarly, the evidence shows that LSAPs have been effective at improving financial conditions as well," he added, referring to long-term asset purchases.
He argued that by pushing down longer-term Treasury yields, "forward guidance and LSAPs have rippled through to other interest rates and boosted other asset prices, lifting spending and the economy."
The goal of the Fed's MBS buying program is to apply additional downward pressure on mortgage interest rates, and Freddie Mac reported last week that the 30-year fixed rate mortgage remained near its all-time low — averaging 3.39%.
"Thanks in part to those rock-bottom rates, we're at long last seeing signs of life in the housing market," Williams said.
"Likewise, cheap auto financing rates have spurred car sales," he continued. "And historically low corporate bond rates encourage businesses to start new projects and hire more workers."
And while it might not have been the Fed's intention, Williams acknowledged the beneficial impact recent policies have had on the U.S. dollar, causing its value to fall against other currencies.
"One estimate is that a $600 billion program like QE2 causes the dollar to fall by roughly 3% or 4%," he said. "That helps stimulate the U.S. economy by making American goods more competitive at home and abroad."
So while it is "devilishly hard" to separate the contribution of monetary policy to the economy from other factors, Williams said using the Fed Board's large scale macroeconomic model: "When we considered the combined effects of QE1 and QE2, we found that these programs had a peak effect of reducing the unemployment rate by 1.5 percentage points. In addition, we found that these programs probably prevented the U.S. economy from falling into deflation."
Williams warned, however, that although the Fed's unconventional policy actions have been effective at lowering interest rates and stimulating economic growth, a great deal of uncertainty remains about the effects of these policies.
"With unconventional monetary policies, we're in waters that have not been extensively charted," he said. "We don't know all the consequences. There is uncertainty about the magnitude of the effects on the economy."
On the FOMC's forward guidance, Williams said while it has proven to be a very useful policy tool, "it's not a perfect substitute for the kind of monetary stimulus that comes from lower interest rates."
One issue, he noted, is that for the forward guidance policy to work as desired, the American public has to believe the FOMC will really carry out the policy as it says it will.
"But, the Fed doesn't have the ability to tie its hands that way," Williams said.
Expectations are "crucial" for forward guidance to be effective, he said, as the public must understand the Fed's intended policy path in order for the forward guidance to work well.
"Therefore, clear communication of policy to the public is a key challenge," Williams said.
Commenting on concerns about the impact of asset purchases, Williams argued that there are no signs of rising inflation on the horizon, while most indications on the risk front still point to an environment of "heightened risk aversion" as opposed to "reckless risk-taking" in the U.S. financial system.
"If that situation were to change significantly, we could modify our unconventional policies to mitigate undesired effects on risk-taking," Williams said.
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