By Steven K. Beckner

NEW YORK (MNI) – Philadelphia Federal Reserve Bank President
Charles Plosser Friday strenuously objected to what he considers the
“breakdown” of traditional boundaries between monetary and fiscal policy
and what he called the “perversion” of central banks “lender of last
resort” role.

Without naming the European Central Bank, Plosser seemed to have
the ECB in mind when he said lending to governments is a “fig leaf” for
debt “monetization.” And he warned that efforts by the ECB and others to
prevent Greek debt default is not preventing the spread of the European
debt crisis.

Plosser, in remarks prepared for delivery to a Monetary Policy
Forum sponsored by the University of Chicago Booth School of Business,
also had harsh words for his own central bank, accusing the Fed of
engaging in fiscal policy with its purchases of mortgage backed
securities and other activities.

He said the “breakdown” of monetary/fiscal barriers is “dangerous
and fraught with long-term risks” and called for a “new accord” between
the Fed and Treasury to reestablish those limits.

Plosser, who is not a voting member of the Fed’s policymaking
Federal Open Market Committee this year but serves on an FOMC
subcommittee on communications, also deplored large-scale deficit
spending in the United States. He said uncertainties about fiscal policy
are creating uncertainty and impeding hiring and investment, thereby
limiting the pace of recovery.

It is the task of a nation’s central bank to maintain the
purchasing power of its currency, but Plosser said “that task can be
undermined or completely subverted if fiscal authorities independently
set their budgets in a manner that ultimately requires the central bank
to finance government expenditures with significant amounts of
seigniorage in lieu of tax revenues or debt.”

He went on to suggest that the central bank’s role in guaranteeing
price stability and protecting the value of the currency is, in fact,
being subverted.

“Unfortunately, over the past few years, the combination of a
financial crisis and sustained fiscal imbalances has led to a
substantial breakdown in the institutional framework and the accepted
barriers between monetary and fiscal policy,” he said.

“The pressure has come from both sides,” he continued. “Governments
are pushing central banks to exceed their monetary boundaries and
central banks are stepping into areas not previously viewed as
acceptable for an independent central bank.”

He proceeded to cite some examples, beginning with “a not-so-subtle
undermining of the commitment to price stability.”

“Despite the well-known benefits of maintaining stable prices,
there are calls in both Europe and the U.S. to abandon this commitment
and create higher inflation to devalue outstanding nominal government
and private debt,” he said.

Plosser warned that “such an inflation tax would transfer wealth
from those who have lent money, in good faith, to the borrowers.”

“I am deeply skeptical of such a strategy,” he said. “Inflation is
a blunt and inappropriate instrument for assigning winners and losers
from profligate fiscal policy or excessive borrowing by private
individuals and firms. Forced redistributions of this kind, if
undertaken at all, should be done through the political process and by
the fiscal authorities, not through the backdoor by the central bank by
way of inflationist policies.”

“As a monetary policymaker, I do not want to be complicit in such a
strategy,” he added, warning that “once inflation is unleashed, it is
not always easy to bring it back down, especially if the central bank
loses the public’s confidence and damages the credibility of its
commitment to price stability.”

Plosser declared that “proposals to use inflation to fix the debt
overhang problem are nothing more than a call for debt monetization to
solve a problem that is fundamentally fiscal in nature.”

Central banks are also coming under government pressure in other
areas, he said. For instance, “in some circles, it has become
fashionable to invoke ‘lender of last resort’ arguments as a reason for
central banks to engage in fiscal actions.”

It is appropriate for a central bank to provide liquidity to
financial institutions that are solvent but facing temporary liquidity
problems, he said, but “recently, some have used the concept to argue
that the central bank should be the lender of last resort to
governments.”

“This is a perversion of one of central banking’s core concepts,”
said Plosser. “It is a fig leaf to conceal the process of monetizing the
sovereign debt of those countries that are insolvent due to their
inability to manage their fiscal affairs. Monetary policy should not be
used to solve a fiscal crisis.”

Plosser said central banks themselves have been guilty of
initiating a breaching of the monetary/fiscal boundaries

“The Fed and other central banks have also undertaken actions that
have blurred the distinction between monetary policy, credit policy, and
fiscal policy,” he said.

Plosser cited the special credit facilities for commercial paper
and asset-backed securities which the Fed launched during the financial
crisis, as well as its purchases of agency mortgage-backed securities
and agency debt.

“When the Fed engages in targeted credit programs that seek to
alter the allocation of credit across markets, I believe it is engaging
in fiscal policy and has breached the traditional boundaries established
between the fiscal authorities and the central bank,” he said, noting
that “some of these actions have generated pointed criticisms of the
Fed.”

Plosser said “the breakdown of the traditional institutional
arrangements as dangerous and fraught with longer-term risks.” He said
the boundaries were created for good reason, “and we ignore them at our
own peril.”

To restore a “bright line” between monetary and fiscal policy,
Plosser repeated past calls for a “new accord” between Fed and Treasury.

“Should the fiscal authority ask the central bank to engage in
lending outside of its normal operations, the fiscal authority should
exchange government securities for the nongovernment assets that would
accumulate on the central bank’s balance sheet as a result,” he said.
“This type of swap would ensure that the full authority and
responsibility for fiscal matters remained with the Treasury and
Congress and the Fed’s balance sheet remained essentially all
Treasuries.”

** Market News International New York Newsroom: 212-669-6430 **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]