By Steven K. Beckner
DENVER (MNI) – Kansas City Federal Reserve Bank President Thomas
Hoenig made a vigorous case against a resumption of quantitative easing
Tuesday, warning that what little benefits “QE2″ might have would be
exceeded its costs.
Hoenig, a voting member of the Fed’s policymaking Federal Open
Market Committee who has dissented all year against the FOMC’s zero
interest rate stance, disputed estimates of how much QE2 would lower
rates. And he said that even if rates are reduced, the economic impact
would be small due to business uncertainty about tax and regulatory
policy.
Besides, he argued, QE2 could lead to resource “misallocation,”
“imbalances” and “volatility.” What’s more, he said it could “unanchor”
inflation expectations and undermine the Fed’s independence because of
perceptions that it is engaging in a kind of fiscal policy by buying
large amounts of government debt.
Hoenig, in remarks prepared for delivery to the annual convention
of the National Association for Business Economics, said it would be
better for the FOMC to let the Fed balance sheet shrink by discontinuing
its policy of reinvesting proceeds of maturing mortgage backed
securities in long-term Treasuries.
As he has before, he advocated that the FOMC end its commitment to
keeping the federal funds rate near zero “for an extended period” and
that it start moving the funds rate to 1%, then “pause.”
Hoenig acknowledged that the Fed is under “considerable pressure
… to ‘do something, anything’ to get the economy back to full
employment.”
But Hoenig stressed that the Fed’s “dual mandate” to promote
maximum employment and price stability is long-run in nature. “The FOMC
must be mindful of this fact and be cautious in pursuing elusive
short-term goals that have unintended and sometimes disruptive effects,”
he said.
Over the last two weeks, key Fed policymakers have made comments
which have been widely interpreted as indicating that the FOMC will
launch QE2 at its Nov. 2-3 meeting. But Hoenig made clear he will be in
vehement opposition.
“I believe there are legitimate reasons to be cautious when
considering this approach,” he said. “A meaningful evaluation of QE2
must consider not simply whether benefits actually exist but, if they
do, how large they are and whether they are larger than possible costs.”
He said “the benefits are likely to be smaller than the costs.”
In an Oct. 1 speech, New York Fed President William Dudley
estimated that $500 billion of securities purchases would be the
equivalent of a 50 to 75 basis point reduction in the federal funds
rate.
But Hoenig countered that “some estimates suggest that purchasing
$500 billion of long-term securities might reduce interest rates by as
little as 10 to 25 basis points.” And he said the impact could well be
even less.
He noted that the $1.7 trillion in large-scale asset purchases that
were concluded in March were “effective, in part, because we were in a
crisis.”
“Financial markets were not functioning properly, or at all, during
the depths of the financial crisis,” he said. “In such a situation, it
is reasonable that central bank purchases would be useful and
effective.”
“However, currently the markets are far calmer than in the fall of
2008,” he continued. “The financial crisis has passed and financial
markets are operating more normally. One could argue, in fact, that with
markets mostly restored to pre-crisis functioning, the effect of asset
purchases could be even smaller than the 10 to 25 basis point estimate.”
Moreover, Hoenig warned, “even if we achieved slightly lower
interest rates, the effect on economic activity is likely to be small.”
He noted that rates have already been brought down to
“unprecedented low levels and kept there for an extended period.” Yet,
“the economy’s response has been positive but modest.”
Echoing a point made recently by Dallas Fed President Richard
Fisher, Hoenig said that “right now the economy and banking system are
awash in liquidity with trillions of dollars lying idle or searching for
places to be deployed or, perhaps more recently, going into inflation
hedges.”
“Dumping another trillion dollars into the system now will most
likely mean they will follow the same path into excess reserves, or
government securities, or ‘safe’ asset purchases,” he said. “The effect
on equity prices is likely to be minor as well.”
“There simply is no strong evidence the additional liquidity would
be particularly effective in spurring new investment, accelerating
consumption, or cushioning or accelerating the deleveraging that is
hopefully winding down,” he added.
Not only are the benefits of QE2 likely to be small, but the costs
are potentially large, Hoenig contended.
“First, without clear terms and goals, quantitative easing becomes
an open-ended commitment that leads to maintaining the funds rate too
low and the Federal Reserve’s balance sheet too large,” he said. “The
result is a further misallocation of resources, more imbalances and more
volatility.”
Hoenig said “there is no working framework that defines how a
quantitative easing program would be managed.” He posed a series of
unanswered questions:
* “How long would the program continue, and what would be the
ultimate size?
* “Would purchases of long-term assets continue until the
unemployment rate is 9% or 8% or even less?
* “Would purchases continue until inflation rises to 2% or 3% or
more?
* “Would the program aim to reduce the 10-year Treasury rate to 2
1/4% or 2% or even less?”
“Without answers to these and other questions, QE2 becomes an
open-ended policy that introduces additional uncertainty into markets
with few offsetting benefits,” Hoenig said.
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