By Steven K. Beckner

(MNI) – Richmond Federal Reserve Bank President Jeffrey Lacker
warned Friday that the Fed is taking undue inflation risks — both with
its asset purchases and with the quasi-commitment to sustained low
interest rates it is making through its communications strategy.

Lacker, who has been the lone dissenter on the Fed’s policymaking
Federal Open Market Committee all year, doubted the third round of
“quantitative easing” would do much good and said the concentration on
buying mortgage-backed securities is an unwarranted “allocation of
credit” by the central bank.

He also expressed strong dismay with the FOMC’s declaration that it
will hold rates down at very low levels even after the economy starts
growing more rapidly.

The FOMC is flirting with inflation, he suggested.

At the conclusion of two days of meetings Wednesday, the FOMC made
no change in policy after taking aggressive actions Sept. 13. The Fed
reaffirmed that it will continue to buy $40 billion of MBS a month until
it sees “substantial” labor market improvement, and will continue its
$45 billion a month “Maturity Extension Program” (Operation Twist)
through the end of the year.

The FOMC also repeated its expectation that the federal funds rate
will stay within a target range of zero to 25 basis points “at least
through mid-2015.” And the FOMC again said it “expects that a highly
accommodative stance of monetary policy will remain appropriate for a
considerable time after the economic recovery strengthens.”

The Fed statement said Lacker had “opposed additional asset
purchases and disagreed with the description of the time period over
which a highly accommodative stance of monetary policy will remain
appropriate and exceptionally low levels for the federal funds rate are
likely to be warranted.”

That was a bit different than the FOMC’s description of his
previous dissent — that he favored the omission of the “mid-2015″ time
period.

Elaborating on his latest dissent, Lacker said he objected to the
FOMC’s stance on three counts.

First, he said he “opposed continuing additional asset purchases”
because “further monetary stimulus now is unlikely to result in a
discernible improvement in growth, but if it does, it’s also likely to
cause an unwanted increase in inflation.”

Lacker noted that “economic activity has been growing at a modest
pace, on average, and inflation has been fluctuating around 2%, which
the Committee has identified as its inflation goal.”

He acknowledged that “unemployment does remain high by historical
standards,” but said “improvement in labor market conditions appears to
have been held back by real impediments that are beyond the capacity of
monetary policy to offset.”

“In such circumstances, further monetary stimulus runs the risk of
raising inflation in a way that threatens the stability of inflation
expectations,” he warned.

Inflation risks could be further enhanced by the Fed’s plan to hold
the federal funds rate near zero even after the economy picks up steam,
Lacker warned.

Second, Lacker said he “dissented because I disagreed with the
characterization of the time period over which the stance of monetary
policy would be highly accommodative and the federal funds rate would be
exceptionally low.”

“I read the Committee statement as saying that the federal funds
rate will be exceptionally low for a considerable time after we observe
a marked increase in the growth of employment and output,” he said.

“I do not believe that a policy conforming to this characterization
would be appropriate, because it implies providing too much stimulus
beyond the point at which rate increases will be required to keep
inflation in check,” he said. “Such an implied commitment would be
inconsistent with a balanced approach to the FOMC’s price stability and
maximum employment mandates.”

Lacker said he does “believe that it is useful for the Committee to
characterize economic conditions under which policy would be likely to
change in the future.” But “specific calendar dates are a highly
imperfect way of doing so.”

Third, reiterating his longstanding position that any asset
purchases should take the form of Treasury securities, Lacker said he
“strongly opposed purchasing additional agency mortgage-backed
securities.”

Buying MBS “can be expected to reduce borrowing rates for
conforming home mortgages by more than it reduces borrowing rates for
nonconforming mortgages or for other borrowing sectors, such as small
business, autos or unsecured consumer loans,” he said.

“Deliberately tilting the flow of credit to one particular economic
sector is an inappropriate role for the Federal Reserve,” he went on.

Lacker cited a Joint Statement of the Department of Treasury and
the Federal Reserve issued on March 23, 2009, which said, “Government
decisions to influence the allocation of credit are the province of the
fiscal authorities.”

** MNI Washington Bureau: 202-371-2121 **

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