–Providing Certain Path For Monetary Policy Could Be Wrong For Economy
–Things Clearly Much Better Now vs. Six Months Ago

By Brai Odion-Esene

GLADWYNE, Pennsylvania (MNI) – The Federal Reserve’s expectation
that interest rates will remain “exceptionally low” through 2014 should
not be taken as a committment, because the date will be discarded once
conditions in the economy change, Philadelphia Federal Reserve Bank
President Charles Plosser said Wednesday.

“I do think we’ve entered 2012 in a little better shape,” and have
weathered some of the storms that hit the economy last year, Plosser
told reporters following a speech to the Main Line Chamber of Commerce
and the Main Line Chamber Foundation.

In response to a question from Market News International, Plosser
said when it comes to the economy, he is more focused on the long-term
outlook, and underlying data trends.

So while there will be ups and downs in economic data, “I do think
that we are on a little firmer footing now, I guess, than we were
certainly six months ago,” he said.

Plosser repeated his attack on the decision by the Federal Open
Market Committee to say economic conditions will warrant interest rates
remaining at exceptionally low levels through 2014, saying he has a more
upbeat outlook while he felt the FOMC’s assessment was too pessimistic.

The late-2014 calendar date would go “out the window” if conditions
in the economy were to change, Plosser warned.

“We are not very clear of the grounds under which we are making
that decision when in fact things are better. And so by continuing to
signal that we want to try to ease more, raises into question our
confidence in the ability of the economy to continue to grow,” he said.

Plosser described the late-2014 date as not being “a very good
piece of communication,” and the central bank has more work to do on the
communications front.

This is why he believes providing a certain path for monetary
policy could be wrong for economy — for instance if monetary conditions
remain accommodative even as the economy is seeing improvement.

Having to hike rates before late-2014 would negatively impact the
central bank’s credibility, Plosser said, not to mention the fact that
it is not good monetary policy if the Fed is “surprising people.”

The Fed instead should be proceed based on how the economy evolves,
Plosser argued, and couch monetary policy in terms of the environment.

Monetary policy responses to the economy should be more
“systematic,” he said.

He also took issue with exactly what “exceptionally low means,”
noting that the federal funds rate could be raised to 1.0% and still be
considered exceptionally low.

In the FFR projections released after the January meeting, FOMC
members’ estimates for the long run path of interest rate coalesced
around 4.0% to 4.5% and Plosser said longer run should be taken to mean
when the economy is at “a steady state.”

When FOMC participants release their FFR projections after the
April meeting, Plosser said it will be important to compare those with
projections made in January, so as to see how their expectations have
evolved.

It is valuable to see how FFR projections change over time, he
said, as it is more informative of what influences policymakers’
decision making.

Many Fed officials have indicated they are less concerned about
inflation so long as unemployment in U.S. remains so high, but Plosser
argued it is “not true” that high unemployment will be sufficient to
keep inflation down.

“It is dangerous” to rely on the tight link between the
unemployment rate and inflation to keep prices down, he cautioned.

Plosser mentioned in his prepared remarks that one of the big risks
to the U.S. economy is the sovereign debt crisis in Europe, noting that
they have “very big” challenges.

“There is still great concern as to how it will all play out,” he
said during a question and answer session with the audience.

Plosser accused Europe’s politicians of dragging the process out,
as they decide who will bear the pain of the real economic losses from
the reforms that need to made implemented.

“It’s much a political debate as it is an economic debate,” he
said.

However, while many worry that an implosion in Europe could cause a
meltdown in the financial markets similar to 2008, Plosser said the
outcome could be quite different.

“U.S. financial institutions in particular have gone a long way to
reducing their exposures to European institutions and sovereign debt,”
he said.

So in some sense U.S. banks are “much less exposed” to what might
happen because they have had between a year and two years to prepare,
Plosser added.

And with the Europe crisis sparking a flight to safety into U.S.
Treasury securities, driving yields to low levels, Plosser said it is
not clear that a major event in Europe would cause liquidity to dry up
in all financial markets or whether the U.S. would be exempt.

Asked what plans the Fed has for the interest it pays on reserves
banks keep at the central bank, Plosser said as the Fed begins raise
rates, it will simultaneously raise both the federal funds rate, and the
interest on reserves.

“At some point, as our balance sheet shrinks back to a more normal
size, there might be a spread between the funds rate target and the
interest on reserves,” he said.

** Market News International **

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