By Steven K. Beckner
LITTLE ROCK, ARKANSAS(MNI) – If Federal Reserve policymakers are going to
replace the expiring “Operation Twist” purchases of long-term Treasury
securities with outright Treasury purchases, and if they want to keep the
current level of monetary stimulus, then they should do so on a less than
one-for-one basis, St. Louis Federal Reserve Bank President James Bullard said
Monday.
Otherwise, the Fed’s policymaking Federal Open Market Committee will be
making monetary policy even more accommodative than it already is, because
outright Treasury purchases would be “more potent” than Twist purchases.
Bullard, who will be a voting member of the FOMC next year, also appeared
to move closer to endorsing a 6-1/2% threshold for raising the federal funds
rate. But he warned that while the present use of a calendar date to signal the
start of rate hikes has problems, economic thresholds pose “six distinct
challenges.”
If the FOMC is going to describe a set of economic conditions or thresholds
it must take great care in how it proceeds and be aware that financial markets
will see thresholds as “triggers for action.”
At their Dec. 11-12 FOMC meeting, Fed policymakers will be deciding how
much and what type of assets to purchase in 2013. The Fed’s Maturity Extension
Program, better known as “Operation Twist,” under which the Fed has been selling
$45 billion a month of short-term Treasury securities and buying an equal amount
of long-term Treasuries, expires Dec. 31.
If nothing is done by the FOMC, aggregate Fed asset purchases will shrink
from a month from $85 billion currently to $40 billion, the amount of
mortgage-backed securities the Fed is buying under the third round of
“quantitative easing.”
MNI reported last week that there is “substantial sentiment” on the FOMC
for fully replacing the expiring Twist purchases with outright purchases,
effectively expanding QE3 to $85 billion. Unlike Twist purchases, outright
purchases would be financed by the creation of new money or bank reserves.
Earlier Monday, Boston Fed President Eric Rosengren, who also will be
voting next year, said he favors a continuation of $85 billion of asset
purchases next year and suggested the Fed should increase the proportion of MBS
purchases.
Bullard did not address the issue of whether MBS would be better than
Treasury purchases, but by implication suggested that he would prefer the
latter.
“Operation Twist can be replaced with outright purchases of Treasury
securities,” he said in remarks prepared for delivery to the Little Rock Chamber
of Commerce. “This is an advantage of the ‘state contingent’ approach to the
balance sheet policy adopted in September.”
But “outright purchases are likely more potent than twist operations,”
Bullard said. “This suggests somewhat less than one-for-one replacement if the
Committee’s intent is to keep policy unchanged.”
“I interpret a one-for-one replacement of twist operations with outright
purchases as more accommodating than the current policy,” he said, adding,
“outright purchases of longer-dated Treasuries with newly created reserves
eliminates the sale of short-term securities and so may be viewed as somewhat
more stimulative.”
“(O)n balance I think it is reasonable to think that an outright purchase
program has more impact on inflation and inflation expectations than a twist
program,” he said. And so “replacing the expiring twist program one-for-one with
outright purchases of longer-dated Treasuries is likely a more accommodating
policy.”
“If the goal is to keep policy on its present course, the replacement rate
should be less than one-for-one,” he added.
Bullard, who has never been comfortable with the use of a calendar date to
signal how long the Fed intends to keep the federal funds rate near zero, said
the FOMC’s current stance of saying it expects to keep the funds rate at that
level “through at least mid-2015″ sends “an unwarranted pessimistic signal.”
“The date can be interpreted as a statement that the U.S. economy is likely
to perform poorly until that time,” he said.
Bullard said using a calendar date is also problematic because the FOMC
“has been reluctant to change the date unless the change in the outlook has been
substantial. This means that markets at times have a somewhat different date in
mind than in the Committee statement.”
Without giving a timeframe, Bullard said the FOMC “may wish to eliminate
the date in the statement in favor of a description of economic conditions at
the time of the first rate increase. Then, as data arrive on U.S. economic
performance, private sector expectations concerning the timing of the first rate
increase would automatically adjust.”
Chicago Fed President Charles Evans last week proposed that the FOMC keep
the funds rate at zero so long as unemployment remains 6.5% or higher and
inflation is 2.5% or less. He had previously favored a 7/3 threshold.
Bullard lent some support to the Evans proposal, saying “the 6.5 value for
the unemployment rate is broadly consistent with mainstream analysis of the
likely value of the unemployment rate at the time of the first increase in the
policy rate. Likewise, many expect inflation to remain low.”
Echoing Fed Vice Chair Janet Yellen, Bullard said such a threshold system
would act as “an automatic stabilizer.”
But Bullard issued a number of caveats.
“Care needs to be taken that this does not represent a return to
1960s-style macroeconomics, in which many thought unemployment could be
meaningfully targeted by the central bank,” he said. “That approach to policy
was badly discredited in the 1970s.”
Besides, he noted that the FOMC’s January 2012 statement on long-term goals
and strategy “makes it clear that the FOMC cannot meaningfully target
unemployment.”
If the FOMC does adopt thresholds in place of a calendar date, it should
use “actual values” for unemployment and inflation, not forecasts, as some
threshold advocates have proposed, Bullard said.
But he said “care should be taken that the Committee does not leave the
impression that only these two variables matter for monetary policy. That would
greatly oversimplify any reasonable judgment concerning the state of the U.S.
economy.”
Bullard said the FOMC should stress that it will be looking at other labor
market indicators besides the unemployment rate, such as payrolls, labor force
participation and hours worked.
And he said the FOMC “needs to emphasize that unemployment can remain
elevated for reasons unrelated to monetary policy.”
Bullard cited the experience of Europe, where high structural unemployment
has proven impervious to monetary easing.
“An unemployment threshold of 6.5% would never have been breached in the
euro zone over the last 20 years,” he said. “Despite this, the ECB did raise the
policy rate at times during this period and did keep the Euro-area inflation
rate near 2%.”
Bullard said the FOMC must also “recognize that thresholds will likely be
treated as ‘triggers for action’ in financial markets.
“In essence, the effect of a threshold announcement is to draw a line in
the sand,” he said. “Crossing the threshold means something significant has
occurred.”
“Even if policy action is not required right at that moment, the
probability of action is increased,” he continued. “Markets will react to the
probability of policy action.”
–MNI Washington Bureau; tel: +1 202-371-2121; email: sbeckner@mni-news.com
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