Hoenig: Some Deflation No Worse Than Some Inflation

Monday, 01 Nov 2010 08:59 AM

 

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Slight deflation is just as acceptable as low inflation, said a senior Federal Reserve official who has persistently dissented against Fed easy money policies, repeating that further easing would be dangerous.

Kansas City Federal Reserve Bank President Thomas Hoenig said the Fed should not have an inflation target but he would like to see an inflation rate of zero.

Prospects of very low inflation, and the resulting low nominal interest rates that give a central bank little room to cut rates sharply in a crisis, is misplaced as it does not allow monetary policy enough time to take effect, Hoenig said in an interview in Saturday's issue of Swiss daily Neue Zuercher Zeitung.

The interview with Hoenig, who has used all six of his votes in 2010 to dissent against the Fed's pledge to hold rates "exceptionally low" for "an extended period," was conducted on October 26 -- the same day that Hoenig warned in a speech that further easing could be dangerous.

The Fed is expected to approve a new round of "quantitative easing" -- essentially printing money by buying bonds -- at its next policy meeting on November 2/3 because many senior officials fear that low inflation could turn into deflation that would make it harder for companies and households to pay off their debts -- already a drag on the U.S. economy.

VOTE

Under the Fed's system of rotating voting positions for regional bank presidents, Hoenig has a vote on the policy-making federal open-market committee (FOMC) this year but not in 2011.

"A little deflation is no worse than a little inflation," Hoenig said in the interview, published in German.

The situation was not comparable with the Great Depression, when prices fell by 20 percent, which was just as bad as price increases of 20 percent, he said.

"Wanting higher inflation is not the same as preventing strong deflation," Hoenig said.

A central bank should aim over time to hold prices stable, or at most tolerate very low inflation, and it was dangerous to argue that monetary policy could reduce unemployment without stoking inflation.

Hoenig said that quantitative easing had succeeded in kick-starting the financial markets but now it had diminishing returns and now that the crisis was over the Fed should allow markets to function normally and reduce its portfolio by allowing bonds it had purchased to mature.

Hoenig cited estimates that long-term rates would fall 25-30 basis points if the Fed embarked on a new round of large-scale quantitative easing.

The Fed had always been quick to pump money into the system in a crisis but slow to withdraw liquidity afterwards, he said.

"Thus the Fed is risking higher inflation for a very small incremental benefit in the form of slightly lower long-term interest rates. I'm not prepared to run that risk," he said.

Hoenig recalled that the Fed had eased monetary policy sharply in 2003 as an insurance against deflation.

"We paid a horrific premium for that if you look at the recent recession. I still believe that the costs of such a policy are higher than generally assumed," he said.

© 2014 Thomson/Reuters. All rights reserved.

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