SAVANNAH (MNI) – The following is the second and final section of
the remarks of Atlanta Federal Reserve Bank President Dennis Lockhart,
prepared Monday for the Savannah Rotary Club:
Pros and cons of QE2
In this walk-through of considerations, pro and con, on the QE2
policy question before Fed policymakers, I could be accused of playing
Hamlet. To cut through it all, let me summarize the case for and the
case against, and then I’ll express my personal opinion.
Proponents of QE2 might argue that not all the headwinds the
economy faces are structural in nature and that further stimulus will
raise demand. Purchases of Treasury securities will lower long-term
interest rates (some of this effect on rates may already have been
priced into the yield curve), and lower rates will generate some
additional purchase and investment activity. And, yes, the portfolio
balance effect and the export effect will raise the economy’s boats.
Taking a defensive perspective, proponents of QE2 argue that the risk of
deflation is not negligible and this potentiality must be forestalled.
Furthermore, patience with the high level of joblessness and
underemployment runs the risk of weakening the fabric of the country if
long-term unemployment erodes skills and creates a permanent class of
unemployed. Finally, proponents may argue that the risks associated with
an even larger Federal Reserve balance sheet-the challenge of a policy
exit or unwinding as the economy improves-are acceptable. The exit tools
are well advanced and scalable. So this is the case in favor.
The case against QE2 at this time goes like this: Further monetary
stimulus will have limited effect. The financial system already has
plenty of liquidity. Interest rates are very low, and lower mortgage
rates, for example, won’t generate a lot of new home buying given
eligibility requirements. Further, the problems besetting the economy
are not fundamentally amenable to a monetary policy solution. They will
take time and depend more on getting clarity on the country’s long-term
fiscal path, taxes, and regulatory impact on businesses. Skeptics also
argue that the Fed, by further expanding its balance sheet, incurs exit
risk that could dislodge inflation expectations and lead to an unstable
inflation situation. Finally, critics of this policy direction may argue
that QE2 amounts to monetization of federal debt in another year of
deficits exceeding $1 trillion. Accusations of monetization could
undermine confidence in the dollar and American monetary policy with
substantial long-term costs.
In my view, the decision is not clear cut. We policymakers have to
weigh these arguments pro and con, potential costs versus benefits, and
competing risks. As I said earlier, I am leaning in favor of additional
monetary stimulus while acknowledging the longer-term risks the policy
may present. At this juncture, and given the circumstances of sluggish
growth and measured inflation that is too low, I give greater weight to
the risk of further disinflation leading to deflation. In my mind, QE2
is a form of risk management-an insurance policy that is prudent to put
in place at this time.
More explicit inflation objective
I am also open to a move that I believe would strengthen the effect
and compensate for potential risks of the policy action-that move is the
adoption of a more explicit inflation objective by the committee. I
believe doing so might serve as a further step to ensure the anchoring
of public expectations about long-term inflation and the response of the
FOMC to adverse price developments. I consider a more explicit inflation
target as something the public could easily understand, and I believe it
would reduce uncertainty at a time when it is badly needed.
You here in Savannah-one of the country’s leading port cities-will
understand the metaphor of navigating shoals. The economic challenges of
the moment call for careful navigation. There are risks accompanying
both action and inaction, but the risks that weigh more heavily on my
mind are those associated with a movement toward deflation. I am
prepared to consider action in the near term that can help avoid that
danger and change the course of the economy for the better.
(2 of 2)
** Market News International **
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