–On Watch For Inflationary Impulses But Job Creation is Urgent Issue

By Brai Odion-Esene

DALLAS (MNI) – Recent policy action by the Federal Reserve “has yet
to show evidence of working,” and the additional unconventional measures
it’s Federal Open Market Committee announced last week could likely
prove ineffective in boosting employment, Dallas Federal Reserve
President Richard Fisher said Tuesday.

In a speech prepared for delivery to a Dallas Assembly luncheon,
while Fisher spoke out against the Fed’s newly announced $400 billion
“Operation Twist” program, he said the decision to reinvest principal
payments from the Fed’s holdings of mortgage-backed securities into more
MBS was “acceptable.”

“Monetary policy is not Thor’s hammer,” the outspoken Fisher
warned, “It is an awesome weapon. But it has limitations.”

“We must carefully harbor its power. If we deploy it incorrectly,
we might level more than interest rates and destroy that which we seek
to create. And if we let it fly too far from our grasp, we may never get
it back. In conducting policy going forward, we must constantly bear
this in mind.”

Fisher, a voter on the FOMC this who has now dissented at the last
two meetings, said the committee’s policy has yet to show evidence of
working and nobody seems to quite understand why.

“I believe, however, that there is significant risk that the
policies recently undertaken by the FOMC are likely to prove ineffective
and might well be working against job creation,” he said.

Fisher acknowledged that he is an inflation hawk, arguing that the
foremost duty of any central banker is to ensure price stability.

Currently, however, Fisher said the consumer basket of 178 items
tracked by the Dallas Fed suggests that headline inflation will decline
from its current level — “just shy of 3% as measured by the PCE and
3.75% as measured by the Consumer Price Index” — to 2%, a level that
the majority of the FOMC believes a tolerable target.

“Thus, while I remain on constant watch for signs of inflationary
impulses, I believe the most urgent issue is job creation and the
reduction of the scourge of unemployment,” Fisher said.

However, Fisher shared his concerns about the prospect of
temporarily allowing more inflation as a means of unlocking expansion in
final demand.

“Indeed, I believe that the Fed cannot deliver on its
congressionally mandated task of seeking full employment unless it
delivers first on its mandated duty of warding off both inflation and
deflation,” he said.

Fisher said he has concerns over the efficacy of the Fed’s latest
unconventional move, in which it will buy $400 billion of longer dated
U.S. Treasuries, while selling an equal amount of shorter term
government debt held by the Fed. The program will be concluded by June

“Embarking on an Operation Twist would provide an even greater
incentive for the average citizen with savings to further hoard those
savings for fear that the FOMC would be signaling the economy is in
worse shape than they thought,” he said. “They might view an Operation
Twist as setting the stage for a new round of monetary accommodation —
QE3, if you will.”

“In addition, such a program might frighten consumers by further
driving down the yields they earn on their savings and/or lead to
long-term inflation that would erode the value of those savings,” Fisher

He also warned that the earning power of banks, both large and
small, would come under additional pressure by suppressing the spread
between what they can earn by lending at longer-term tenors and what
they pay on the shorter-term deposits they take in.

Pension funds would also have to reassess their potential returns,
Fisher continued, with the consequence that public and private
direct-benefit plans would have to set aside greater reserves that might
otherwise have gone to investments stimulating job creation.

“Expanding the holdings of the Fed’s book of longer-term debt would
likely compound the complexity of future policy decisions,” Fisher said.
“Perversely, the stronger the economy, the greater the losses the Fed
would incur as interest rates rise in response and the prices of those
longer-term holdings depreciate.”

There is also political pressure to consider, he added, as the
political incentive to hold rates down might then become stronger
precisely when the FOMC wants to initiate tighter monetary policy.

Fisher added that one other factor that gave him pause is the moral
hazard of being too accommodative. He repeated his belief that monetary
policy cannot solve the problem of substandard economic performance
unless it is complemented by fiscal policy and regulatory reform “that
encourages the private sector to put to work the affordable and abundant
liquidity we are able to create as the nation’s monetary authority.”

“These actions are not within the Fed’s purview; they are the
business of Congress and the president,” he said. “Further monetary
accommodation — be it in the form of quantitative easing or performing
‘jujitsu’ on the yield curve through efforts such as Operation Twist —
will represent nothing more than pushing on a string.”

Fisher had more positive words for the FOMC’s announcement last
week that it would reinvest principal payments from its holdings of
agency debt and agency mortgage-backed securities in agency
mortgage-backed securities.

He noted that since the beginning of the year, the spreads between
mortgage-backs and Treasuries have been widening and have accelerated,
especially lately, to levels last seen in early 2009.

“This decision, while not expected by the markets, was acceptable
for me as a tactical way to provide limited assistance to the mortgage
market at little cost,” Fisher said.

“The decision to embark on an ‘Operation Twist,’ however, was a
strategic decision where I did not feel the benefits outweighed what I
perceived to be the costs,” he added.

Fisher concluded that despite his opposition, in the end, the
decision taken by the FOMC is that of the majority, and the majority
supported the measures that were announced. “We must now hope that they
will work.”

** Market News International Washington Bureau: 202-371-2121 **

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