By Steven K. Beckner
(MNI) – Richmond Federal Reserve Bank President Jeffrey Lacker said
Monday that the Federal Open Market Committee’s decision last Tuesday to
extend its expectation of keeping the federal funds rate “exceptionally
low” through mid-2013 was not warranted, but he emphasized the Fed’s
policymaking body did not lock itself into keeping the funds rate near
zero.
The FOMC’s new “forward guidance” is “highly contingent” and
subject to change as economic and/or inflation circumstances evolve,
Lacker said in an interview with Market News International.
Nevertheless, Lacker warned that the Fed is courting
increased inflation with its extraordinarily stimulative monetary
policies.
And he expressed strong opposition to proposals that the Fed
deliberately allow inflation to run well above its implicit 1.7% to 2.0%
target for a time in an effort to spur economic growth.
Lacker, who opposed the Fed’s $600 billion second round of
quantitative easing last November, indicated he would only support a
“QE3″ in the unlikely event that the inflation rate was to fall such an
extent that outright deflation was becoming a threat. He recalled that
he opposed the $600 billion QE2 program that was launched last Tuesday.
Lacker, who will be an FOMC voter next year, declined to say
whether or to what extent the FOMC discussed QE3 last Tuesday. He also
did not want to say whether the new “forward guidance” was a Fed
Chairman Ben Bernanke’s preferred action or whether it represented a
“compromise” between those who wanted to do nothing and those who wanted
QE3.
But he said “to some extent this is the first step one would take
if one were going to take a step.”
Lacker said he has become less optimistic about the economic
outlook than he was a few months ago, but said he does not see the
United States heading back into recession and suggested the inflation
risks are to the upside, not the downside.
Despite recent repercussions of the European debt crisis on Wall
Street, he said the U.S. financial system and in turn the economy are
less vulnerable to shockwaves from Europe than they would have been
before various banking reforms were instituted.
On Aug. 9, the FOMC refrained from approving QE3 as some had hoped,
but incurred a rare three dissents when it dramatically altered the
“extended period” language in its policy statement. After reaffirming its
zero to 25 basis point funds rate target, it declared, “The Committee
currently anticipates that economic conditions–including low rates of
resource utilization and a subdued outlook for inflation over the medium
run–are likely to warrant exceptionally low levels for the federal
funds rate at least through mid-2013.”
Asked about his stance on the extension of the extended period,
Lacker said “it doesn’t strike me that more monetary stimulus is what
this economy needs.”
“I didn’t think it was warranted,” he said. “For me, I think
monetary policy has done what it can.”
Many have read the FOMC statement as virtually guaranteeing that
the Fed will hold the funds rate near zero for at least another two
years, but Lacker said that is not a valid interpretation.
“I would note that it’s a fairly mild statement in the sense that
it’s highly contingent,” he said. “It’s a commitment that could change
if economic data indicate.”
Some have suggested that it will be difficult for the FOMC to back
out of what is widely perceived as a promise to keep the funds rate near
zero through at least the middle of 2013. But Lacker said, “I think that
if the economic data come in differently than the Committee expected
then I think that will provide the opportunity to alter the terms of
that statement.”
“That statement isn’t so much a commitment as it is a forecast,” he
added.
Various objections have been raised to a two-year quasi-commitment
to holding the funds rate so low — that it would benefit large
borrowers at the expense of savers, that it could cause a speculative
search for yield that might create new asset bubbles and that it could
render the interlink money market distinctional.
Lacker acknowledged those potential costs, but indicated those are
not his primary concerns.
The trade-off between savers and borrowers is “always part of the
mix when we change policy and change the interest rate trajectory,” he
said.’
As for interbank funding issues, Lacker said “being near zero does
have some operational implications for how some wholesale money markets
work,” but he added, “those seem manageable in the short-run.”
And he added, “the broader question of risk appetites and search
for yield is to some extent separate from level of interest rates. A
search for yield can arise whether interest rates are low, moderate or
high … . I don’t see that per se as a by-product of a low interest
rate.”
Lacker said his main objection to the extended zero rate policy is
directed elsewhere: “For me predominantly, it’s a matter of money
creation and inflation.”
“We operate monetary policy by moving short-term interest rates
around over the business cycle,” he explained. “We do that because
what’s required to get the money supply right, to keep inflation low and
stable, a lower interest rate is required when the economy is soft, and
a higher interest rate is required when the economy is strong.”
“If we get the interest rate wrong we’re going to get the money
supply wrong, and that’s going to get inflation wrong,” he continued.
“And that’s why we vary interest rates with economic conditions the way
we do. People confuse that with providing stimulus and working to offset
shocks to growth, positive or negative.”
“So for me the chief risk is that it creates the ingredients for
an acceleration of inflation.”
Bernanke and others have often argued that the expansion of bank
reserves does not pose an inflation threat, because those reserves are
not flowing into the economy via bank loans and expanding the
broad money supply.
Lacker agreed that “so far the banking system has absorbed the
large supply of reserves without igniting inflationary pressures.” But
he warned, “as time goes on there’s going to be the risk that those
conditions shift in a way that make those reserves more inflationary
than they are now.”
Lacker said he is anticipating that inflation will run “about 2% or
perhaps a little less over the next year or two.”
However, he warned, “there are likely to be upside risks to
inflation over the next couple of years” because “we’ve got a
tremendous amount of monetary policy stimulus in place, and it’s
going to be a challenge to assess that going forward.”
Lacker said it will be critical for the Fed to tighten monetary
policy in a timely way to avoid an acceleration of inflation.
He said he broadly agrees with the exit strategy laid out by the
FOMC at its April meeting, but said “if I had my druthers I would sell
assets earlier in the process.”
But he said timing the start of the exit is “going to be harder
than the sequence question.”
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** Market News International **
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