–Monetary Policy Normalization ‘Will Take Time’
–Growth Prospects ‘Remain Reasonably Good’ For 2011

LONDON (MNI) – St. Louis Federal Reserve President James Bullard
Wednesday night said the debate over how the Fed normalizes monetary
policy “will likely return as a key issue” this year, but stressed that
withdrawing the massive amounts of monetary stimulus will take time.

In a presentation to members of various financial institutions
Wednesday at the UBS Macro Dinner in London, Bullard said “U.S. growth
prospects remain reasonably good for 2011,” noting that the growth
outlook improved since the Fed’s $600 billion asset purchase program was
implemented.

However, U.S. monetary policy cannot remain extremely accommodative
indefinitely, said Bullard, who is not a voter on the Federal Open
Market Committee this year.

“Exit strategy was widely discussed in 2010, and that debate will
likely revive during 2011,” he added. “Discussion of the normalization
of U.S. policy will likely return as the key issue in 2011.”

Normalization has two parts he said: removing the QE accommodation
by returning the balance sheet to an ordinary size over time, and
raising the Fed’s policy rate to levels associated with moderate
expansion.

“This will take time,” Bullard said, but repeated his warning that
“the FOMC may not be willing or able to wait until all global
uncertainties are resolved to begin normalizing policy.”

He also that one complication the Fed will likely face, compared to
previous tightening cycles, is that reversing QE through balance sheet
normalization “will put upward pressure on interest rates.”

Also, while the “natural debate is how and when the exit should
begin,” Bullard said, “additional uncertainty has clouded this picture.”

This uncertainty stems from four key sources, he continued, the
disaster in Japan, the turmoil in the Middle East and Libya — and the
associated uncertainty premium in oil prices — the U.S. fiscal
situation and the threat of a government shutdown, and uncertainty
regarding resolution of the European sovereign debt crisis.

“All four situations contain potential for escalation. If
escalation occurs, all bets are off,” Bullard said.

If escalation occurs, he added, how and when to begin normalizing
monetary policy would become less clear.

“Still, the most likely prospect is that all four are resolved
without becoming global macroeconomic shocks,” Bullard said.

Oil prices would have to continue to increase substantially to
derail U.S. growth prospects “significantly,” Bullard said, while if
Japan contains the fallout at the Fukushima Daiichi nuclear plant,
uncertainty regarding the natural disaster and the damaged nuclear
reactors there will be reduced.

On the domestic front and the stand-off over the fiscal year 2011
budget, the St. Louis Fed president said if Congress funds the
government through 2011 and makes some progress on deficit reduction,
“uncertainty about the U.S. fiscal situation and the possibility of a
government shutdown will be lessened.”

As for Europe, when EU governments approve a plan to address
continuing sovereign debt concerns, that uncertainty will also be
reduced, he predicted.

Listing the ways through which the Fed could exit from highly
accommodative policies — IOER, asset sales, reverse repos — Bullard
said the Fed has learned its lesson from tightening cycles in 1994 and
2004.

“In 1994, the Fed tightened policy unexpectedly and in uneven
amounts,” and the financial market effects were considered disorderly,
he noted. Policy was then normalized, and the economy boomed for the
rest of the decade.

“In 2004, the Fed tightened policy in perfectly even amounts,” he
continued, and although the financial markets effects were considered
orderly, the financial crisis is sometimes blamed in part on this
excessively smooth approach.

“This time, it will be just right!” Bullard concluded.

** Market News International **

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