By Steven K. Beckner
Hoenig also asked, “As central bank assets expand under
quantitative easing, what will be the exit strategy?”
He said the Fed “must define an exit strategy if the objective is
to raise inflation but contain interest rate expectations, but he
questioned whether the Fed can do that effectively.
“If history is any indication, without an exit strategy the natural
tendency will be to maintain an accommodative policy for too long,” he
said. “While I agree that the tools are available to reduce excess
reserves when that becomes appropriate, I do not believe that the
Federal Reserve, or anyone else, has the foresight to do it at the right
time or right speed.”
“It may work in theory,” he said. “In practice, however, the
Federal Reserve doesn’t have a good track record of withdrawing policy
accommodation in a timely manner.”
A second “cost” of QE2, according to Hoenig, is that “we risk
undermining Federal Reserve independence.”
“QE2 actions approach fiscal policy actions,” he said. “Purchasing
private assets or long-term Treasury securities shifts risk from
investors to the Federal Reserve and, ultimately, to U.S. taxpayers. It
also encourages greater attempts to influence what assets the Federal
Reserve purchases.”
“When the Federal Reserve buys long-term securities — such as the
$1.2 trillion in mortgage backed securities it purchased during the
financial crisis — it favors some segments of the market over others,”
he continued. “And when the Federal Reserve is a ready buyer of
government debt, it becomes a convenient source of cash for fiscal
programs.”
“During a crisis this may be justified, but as a policy instrument
during normal times it is very dangerous precedent,” he added.
A third cost is that “rather than inflation rising to 2 or 3%, and
demand rising in a systematic fashion, we have no idea at what level
inflation might settle. It could remain where it is or inflation
expectations could become unanchored and perhaps increase to 4 or 5%.”
“Not knowing what the outcome might be makes quantitative easing a
very risky strategy,” he said. “It amounts to attempting to fine-tune
inflation expectations — a variable we cannot precisely or accurately
measure — over the next decade.”
Hoenig said the size of the federal deficit, combined with an
expanded Fed balance sheet “will influence inflation expectations.”
“Expanding the balance sheet by another $500 billion to $1 trillion
over the next year, and perhaps keeping the balance sheet at $3 trillion
for the next several years, or increasing it even further, risks
undermining the public’s confidence in the Fed’s commitment to long run
price stability, a key element of its mandate,” he warned.
Hoenig said “the FOMC has never shown itself very good at
fine-tuning exercises or in setting and managing inflation and inflation
expectations to achieve the desired results” and added that “inflation
expectations might very well increase beyond targeted levels, soon
followed by a rise in long-term Treasury rates, thereby negating one of
the textbook benefits of the policy.”
Instead of resuming Q.E., Hoenig argued that “with a modest
recovery underway and inflation low and stable, I believe the economy
would be better served by beginning to normalize monetary policy…..”
“First, rather than expand the Federal Reserve’s balance sheet by
purchasing additional U.S. Treasury securities, the Fed should consider
discontinuing the policy of reinvesting principal payments from agency
debt and mortgage-backed securities into Treasury securities….”
He said such a change should be made “slowly but systematically.”
“Second, we should take the first early steps to normalize interest
rate policy,” he went on. “This is not a call for high rates but a call
for non-zero rates.”
“Also, any effort to renormalize policy would include signaling a
clear intention to remove the commitment to maintain the federal funds
rate at 0 to 0.25% ‘for an extended period,'” he said. “As the public
adjusts to this, we should then turn to determining the pace at which we
return the funds rate to 1 percent.”
“Once there, we should pause, assess and determine what additional
adjustment might be warranted,” he said, adding that a 1% federal funds
rate would still be “extremely accommodative.”
Maintaining zero rates has “possible unintended consequences,” he
said. “Zero rates distort market functioning, including the interbank
money and credit markets; zero rates lead to a search for yield and,
ultimately, the mispricing of risk; zero rates subsidize borrowers at
the expense of savers.”
Anyway, Hoenig said, rate levels aren’t really the problem for the
economy.
“(B)usiness contacts continue to tell me that interest rates are
not the pressing issue,” he said. “Rather, they are concerned with
uncertainties around our tax structure; they are desperate to see this
matter settled. They need time to work through the recent healthcare
changes; and they are quite uncertain about how our unsustainable fiscal
policy will be addressed. They are insistent that as these matters are
addressed, they will once again invest and hire.”
“QE2 cannot offset the fundamental factors that continue to impede
our progress,” he said.
“If we have learned anything from this crisis, as well as past
crises, it is that we must be careful not to repeat the policy patterns
we have used in previous recoveries, such as 1990-91 and 2001,” Hoenig
concluded. “If we again leave rates too low for too long out of fear
that the recovery is not strong enough, we are almost assured of
suffering these same consequences yet again. I am fully committed to the
Federal Reserve’s dual maintain to maintain long-run growth so as to
promote effectively the goals of maximum employment, stable prices and
moderate long-term interest rates.”
Hoenig prefaced his opposition to QE2 by making cautiously upbeat
comments on the economy.
“Currently, a major and necessary rebalancing is taking place
within our economy,” he said. “(T)he economy has slowed but it has not
faltered.”
Pointing to gains in spending, industrial production and jobs, he
said “While modest, these are positive trends for the U.S. economy.”
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** Market News International **
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