By Steven K. Beckner
Critics of QE2, including some Fed policymakers, have expressed
concern that it will complicate the Fed’s task of eventually exiting
from its easy money policy and that the Fed will overstay accommodation
as it did earlier in the decade.
Bullard said “the overstaying is a very legitimate concern,” but he
said “that’s a very traditional monetary policy issue.”
“Even if we were completely in the normal world of interest rate
targeting there would still be people saying you’re not ready to raise
rates when you should and so on,” he explained. “So it’s always the
hardest decision in the monetary policy world is to start a tightening
campaign.”
“And so it’s a very delicate thing, and I respect that, and I
respect that the history maybe isn’t the best on that,” he continued.
“But I don’t think there’s anything new about that. That’s always a
problem in monetary policy.”
Kansas City Fed President Thomas Hoenig, who dissented against QE2
last week, has warned that, if QE2 doesn’t work as well as hoped, the
Fed could get on a sort of slippery slope in which it is tempted to buy
more and more assets, piling up more and more bank reserves, from which
it would find it hard to extricate itself.
Bullard said that’s one reason why he “would not announce big (QE2)
numbers” in advance but “would just start going month to month.” He said
he still hopes he’ll “be able to convince my colleagues that that’s the
way to do it.”
Beyond that, he said Hoenig’s concerns could be addressed by
letting it be known it will actively shrink its balance sheet.
He noted that the Fed can use reverse repurchase agreements and
term deposits to absorb reserves and can increase the interest it pays
on excess reserves if it decides that reserves are flowing into the
economy too quickly. But he was skeptical of relying too much on those
tools alone.
“I’m not sure the Committee has really come to grips with how we’re
going to operate monetary policy in that environment once we come off of
zero,” he said. “That’s a looming issue still.”
“You could use term deposits, reverse repos and take a lot of
reserves out of the system, then you could raise the funds rate if
that’s the way you want to approach things,” he continued. “So I do
think we have the tools.”
But he added, “I’d be for managing down the balance sheet first and
then going to those tools later.”
Bullard made clear his own preference: asset sales. “I would like
to set up expectations that one day when the economy is performing
better and we judge that the risks of any further expansion are too high
and that we’ve made better progress toward our goals that we’d start
shrinking balance sheet by selling off assets at some point.”
“At this point it’s some way down the line because we haven’t been
making that great a progress lately,” he said. “But I would hope that
would mitigate some of President Hoenig’s concerns if we could get that
idea to take hold among the Committee members that that’s the way we’d
shrink the balance sheet.”
“We’d progressively manage the balance sheet down as the economy
improves just the way that we manage the balance sheet up in order to
ease financial conditions,” he added.
Bullard acknowledged that shrinking the balance sheet is “a long
way in the future. But as far as style, as far as the way we would be
able to manage the exit, I would hope that we could manage it down as
opposed to having a passive policy of just allowing the run off to occur
and not replacing it.”
Addressing the belief in some quarters that the Fed is
accommodating heavy Treasury borrowing to finance deficit spending or
“monetizing the debt,” Bullard said he is “very cognizant of” the need
to avoid even the perception that it is not an independent central bank.
“Of course at the pace we’re buying we are a big player in
absorbing the new issues of the Treasury,” he said. “So I am pretty
concerned about this issue.”
However, he added, “I think that has to be weighed against the fact
that without doing anything there is a drift toward further disinflation
and, you know, how long do you want that to go on before you get into a
Japanese style situation.”
Bullard said he sees “this (QE2) decision as a bit preemptive on
that. The inflation numbers are low, but they’re not so low that action
was imperative. So for that reason I would interpret the action as being
somewhat preemptive in trying to avoid a Japanese outcome for the U.S.”
He repeated his warning that “just staying at zero and promising so
to say at zero for a long time really risks this problem that you get
less and less inflation, real rates will continue to rise, output will
continue to fall and you’ll really stagnate and you’ll get into this
zero interest rate, mild deflation scenario.”
“So yeah, there is the risk of appearances that you’re monetizng
the debt, but there’s also the risk of doing nothing,” he added.
As for the risk that the Fed could lose creditability if QE2 doesn’t
work, Bullard observed again that it has already lowered interest rates
and had other beneficial effects in financial markets, so “that hurdle
has been passed.”
“Now, is that going to have an impact on the economy?” he asked.
“Well, for that you have to look out six to nine months and then you’re
going to have to disentangle between all the other things that are going
to happen over the next six to nine months. I don’t know what they are.”
“But that’s a normal problem in monetary policy where even when you
lower interest rates you’re not sure how much impact you had versus all
the other shocks that hit the economy in the meantime.”
Regarding fiscal policy, Bullard said, “I think it’s critically
important that the U.S. gets its fiscal house in order, and we have been
sent this tremendous warning from European countries that borrowed too
much and the international markets lost faith in those economies, and
then they had to borrow at very high rates and they really got into a
very difficult situation.”
“So I think it is very important we get our fiscal situation under
control,” he continued. “It means tackling very difficult issues
what have historically been difficult issues for the Congress to tackle.
So this is of first order importance for the U.S.”
“If we could get some kind of agreement on the longer term picture
for the U.S. and put ourselves on a path to fiscal solvency it would
just help tremendously,” he went on. “It would give us more flexibility
for those who want to do something else in the short-term. But we really
do have to address this situation.”
When the Fed eventually raises rates it will increase interest on
the national debt — one of the largest components of the federal
budget, over which Congress has no control, Bullard conceded. But he
pointed out that the Fed would be “raising rates because you don’t want
inflation to get out of control … . If inflation gets out of control
rates are going to go up anyway.”
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** Market News International **
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