Philadelphia Fed Chief Plosser: QE3 Risks Fed Credibility, Won’t Boost Employment

Tuesday, 25 Sep 2012 01:06 PM

 

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Federal Reserve Bank of Philadelphia President Charles Plosser said new bond buying announced by the Fed this month probably won’t boost growth or hiring and may jeopardize the central bank’s credibility.

“We are unlikely to see much benefit to growth or to employment from further asset purchases,” Plosser said in the text of a speech prepared for delivery Tuesday at the Reserve Bank in Philadelphia. “Conveying the idea that such action will have a substantive impact on labor markets and the speed of the recovery risks the Fed’s credibility.”

The Federal Open Market Committee said Sept. 13 that it will undertake a third round of quantitative easing by purchasing mortgage-backed securities at a pace of $40 billion per month until labor markets “improve substantially.” Policy makers are using unconventional tools to attack a jobless rate stuck above 8 percent since February 2009.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

Economic research indicates that additional asset purchases are “unlikely to reduce long-term interest rates by a significant amount” and that lowering rates “by a few more basis points” won’t spur growth and hiring, said Plosser, who doesn’t have a vote on policy this year. The U.S. economy is growing “at a moderate pace” and probably will expand by about 3 percent in 2013 and 2014, he said.

‘Meager Benefits’

“I opposed the Committee’s actions in September because I believe that increasing monetary policy accommodation is neither appropriate nor likely to be effective in the current environment,” Plosser said. “Every monetary policy action has costs and benefits, and my assessment is that the potential costs and risks associated with these actions outweigh the potential meager benefits.”

The FOMC also said this month it will probably hold the federal funds rate near zero at least through mid-2015. The Fed had forecast since January that rates will stay low at least through late 2014.

In addition, the Fed said on Sept. 13 “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” The Standard & Poor’s 500 Index rose to 1,465.77 on Sept. 14, the highest close since December 2007.

The Fed’s “hard-won credibility” is crucial because if the public doesn’t have confidence in policy makers, their ability to set effective monetary policy will be harmed, hurting households and businesses, Plosser said. If people believe the central bank will delay raising rates, they may “infer that the Fed is willing to tolerate considerably higher inflation,” spurring an increase in inflation expectations that would require a response from the FOMC, Plosser said.

‘Significant Risks’

“The Fed’s most recent actions carry with them significant risks,” Plosser said. “I am not forecasting that those risks will necessarily materialize and I hope they will not. But if they do, they could prove quite costly to the economy.”

Before announcing QE3 this month, the Fed expanded its balance sheet with two prior rounds of bond purchases. In the first, starting in 2008, the Fed bought $1.25 trillion of mortgage-backed securities, $175 billion of federal agency debt and $300 billion of Treasurys. In the second round, announced in November 2010, the Fed bought $600 billion of Treasurys.

Minneapolis Fed President Narayana Kocherlakota, who doesn’t vote on policy this year, endorsed additional easing on Sept. 20, saying interest rates may need to stay close to zero for four years to cut unemployment.

‘Extraordinarily Low’

As long as inflation doesn’t exceed 2.25 percent, the Fed “should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent,” he said in a speech. Last May he said borrowing costs may have to rise as soon as this year.

Richmond Fed President Jeffrey Lacker, who votes on the FOMC this year and was the only policy maker to dissent at the last meeting, said QE3 probably won’t do much to boost the labor market. “This is going to have a greater effect on inflation and a minimal impact on jobs,” Lacker said in a Sept. 15 interview on National Public Radio.

Similarly, Richard Fisher of Dallas, who doesn’t vote on monetary policy this year, opposed the third round of purchases, which he said led to an increase in market expectations for higher inflation without more job creation. “I do not see an overall argument for letting inflation rise to levels where we might scare the market,” Fisher said in a Bloomberg Radio interview.

Limited Benefits

Plosser said before the last FOMC meeting that the potential risks involved with another round of large-scale asset purchases outweigh the benefits.

“I don’t think it really meets the cost-benefit test right now,” Plosser said in an Aug. 30 CNBC interview. “It’s possible they could bring down interest rates somewhat, but we have to remember it’s not that simple given the headwinds that the economy faces.”

Plosser, 64, became president of the Philadelphia Fed in August 2006. He was previously dean of the graduate school of business administration at the University of Rochester in New York State. The Philadelphia Fed will next have a vote on policy decisions in 2014.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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