–Fed Shouldn’t Bow To Market Expectations

By Steven K. Beckner

DENVER (MNI) – Aside from “unanchoring” inflation expectations and
fuelling potential asset bubbles for little economic gain, Kansas City
Federal Reserve Bank President Thomas Hoenig warned Tuesday that a new
round of quantitative easing could intensify international currency
market tensions.

Hoenig, a voting member of the Fed’s policymaking Federal Open
Market Committee, said the FOMC cannot hope to “fine tune” inflation
expectations and risks losing control of them and the value of the
dollar. His comments came as he continues to swim against the tide of
support for “QE2″ in response to audience questions at the annual
convention of the National Association for Business Economics.

Hoenig said the FOMC should resist the temptation to launch QE2
simply because the market expects it.

Asked whether the FOMC should care about global “spillover effects”
from QE2, he replied, “We absolutely should care about that.”

Hoenig suggested that the mere anticipation of renewed QE by the
Fed has contributed to currency “tensions” that were on display at this
past weekend’s annual meetings of the International Monetary Fund and
World Bank.

He noted that Bank of Japan Governor Masaaki Shirakawa was quoted
as saying the BOJ resorted to QE because “if the world is going to
engage in quantitative easing” then the BOJ has to “be in the game”
because of the effect on the yen’s exchange rate.

Downplaying deflation risks, Hoenig noted that, notwithstanding the
“serious shock” the economy has endured, core inflation is about 1%,
“not zero.” He said it’s possible the inflation rate will fall closer to
zero, but said the fact that the Fed has a $2.3 trillion Fed balance
sheet “gives me some sense we should not see deflation.”

Of greater concern to him, he made clear, was the possibility of
asset price bubbles and ultimately excessive inflation as the Fed
“throws money” at the economy.

“Throwing this money at it has short-term has the feel of doing
something and the long-term effect of really doing something,” he said,
putting emphasis on “really.”

Hoenig said the Fed cannot possibly “fine tune inflation
expectations” and warned that if it tries it could get onto a slippery
slope of having to feed more and more QE into the market to achieve its
objectives.

If a half trillion of bond purchases have little effect on
inflation expectations and/or inflation, he said the temptation will be
for the FOMC to vote another $500 billion to edge it marginally higher,
and then perhaps another $500 billion and another $500 billion.

Once the Fed gets the inflation rate up to 2% or more, he said the
temptation will be to let it exceed 2% for awhile to make up for
previous years of below-target inflation.

“Now the economy takes off and inflation is 5,” he said.

“As desperate as I am to get unemployment down I don’t want to take
short-term risks” that have long-term adverse consequences, he said.

At the NABE conference earlier Tuesday, PIMCO senior vice president
Tony Crescenzi said the FOMC has little choice but to approve additional
quantitative easing at its Nov. 3 meeting because of market
expectations. This gave rise to a question as to whether the Fed must
“follow the markets.”

Hoenig said the Fed “has to be careful” not to “signal” certain
actions that “affect expectations” because those expectations then
“affect the central bank’s ability to act.”

“I am concerned that we not be subject to the market’s demands,” he
said, adding that at times the Fed may have to surprise the markets and
let them adjust.

“We shouldn’t follows the markets,” he said.

** Market News International **

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