–Not Supportive Of Recent FOMC Decision; Conditions Modestly Improved
–‘If Economic Conditions Change Then So Will Policy’

By Brai Odion-Esene

GLADWYNE, Pennsylvania (MNI) – Philadelphia Federal Reserve Bank
President Charles Plosser Wednesday argued there is little justification
to loosen monetary conditions further, given his expectation that labor
markets will continue to improve, with job creation strengthening and
the unemployment rate falling gradually over time.

Plosser — a noted policy hawk — also said he expects the U.S.
economy to continue growing at a moderate pace, while inflation
expectations will be relatively stable and prices will moderate in the
near term.

The thrust of Plosser’s speech, prepared for delivery to the Annual
Meeting of the Main Line Chamber of Commerce and the Main Line Chamber
Foundation, was aimed at the announcement by the policymaking Federal
Open Market Committee last week that economic conditions were “likely to
warrant exceptionally low levels for the federal funds rate at least
through late 2014.”

“I was not supportive of the most recent decision to extend the
time frame for exceptionally low rates through 2014,” said Plosser, who
will not be a voter on the FOMC until 2014.

“In my view, economic conditions have modestly improved since our
December meeting, especially on the employment front, and the downside
risk of a double-dip recession that many feared in September when the
Committee instituted ‘operation twist’ has substantially abated,” he
added. “Thus, with the economy gradually improving, I saw little
justification to further ease monetary policy and felt it risked
undermining confidence in the process.”

Just like when he dissented in 2011 against the initial mid-2013
timeframe for low rates and the introduction of ‘Operation Twist,’
Plosser said he believes the benefits of further monetary policy easing
are “small at best,” and will do little to tackle the jobs crisis.

“But the potential costs of this further accommodation could
translate into a steady rise in inflation over the medium term, even
without much of a drop in the unemployment rate. In my assessment, the
potential costs of further accommodation outweighed the potential
benefits,” he said.

Plosser also took issue with the FOMC’s practice of offering
forward guidance by saying economic conditions are likely to lead to low
rates through a particular calendar date.

“Monetary policy should be contingent on the economic environment
and not on the calendar,” he said.

And there was a warning for those who expect short-term interest
rates to remain at zero at least until late 2014: “The FOMC has made no
such commitment and the statement indicates as much — if economic
conditions change, then so will policy,” Plosser said.

For the first time following the January meeting, FOMC members
provided their projections for the likely path of the federal funds rate
over the medium term along with their regular forecasts for growth,
inflation and the unemployment rate.

“Policymakers’ views will evolve as the economy evolves. So, the
expanded SEP will add an important perspective not just of prospective
policy at a point in time, but of how the policy projections are
influenced as economic conditions change,” Plosser said.

He argued that expanding policymakers’ assumptions to include FFR
projections “conveys more useful information about the likely future
path of monetary policy than using a calendar date as we have been
doing.

“I remain committed to working to increase the clarity of the Fed’s
public communications about current economic conditions, the economic
outlook, and our policymaking framework,” he said.

As noted above, Plosser had a more optimistic outlook for the
economy compared to assessment by the FOMC, predicting the U.S. will
continue to see moderate growth of around 3% for 2012 and 2013.

And although there is a long way to go before the labor market is
back to pre-recession levels, Plosser said he is encouraged by the
employment reports released over the past several months.

“As growth continues and strengthens, I expect further gradual
declines in the unemployment rate, with the rate falling to around 8% or
a little less, by the end of 2012,” he declared.

Falling commodity prices, and relatively stable inflation
expectations, means inflation will moderate in the near term, Plosser
said.

He remains concerned, however, about the medium term.

“Given the very accommodative monetary policy that has been in
place for more than three years, I believe we must continue to monitor
inflation measures very carefully,” Plosser said.

“Inflation most often develops gradually, and if monetary policy
waits too long to respond, it can be very costly to correct,” he warned.
“Thus, we need to proceed with caution as to the degree of monetary
accommodation we supply to the economy.”

After its January meeting, the FOMC also issued a consensus
statement of its longer-run goals and policy strategy, and explicitly
stated its goal for inflation as 2%, as measured by the year-over-year
change in the overall personal consumption expenditures chain-weighted
price index.

Plosser said not only will an explicit inflation objective enhance
the credibility of the Fed’s commitment to price stability, but it also
affords the central bank more flexibility in the short run “as it
attempts to mitigate the fluctuations in output and employment in the
face of significant economic disturbances.”

“On the other hand, maximum employment is largely determined by
factors that are beyond the direct control of monetary policy … The
FOMC cannot set a fixed numerical objective for something that it does
not directly control and cannot accurately measure,” he added.

Plosser’s upbeat outlook for the economy, however, does not extend
to the housing market.

“I expect to see stabilization but not much improvement in 2012,”
he predicted, adding that a housing recovery is unlikely “until the
surplus inventory of foreclosed and distressed properties declines.”

Plosser went on to caution that even as the economy rebalances, “we
should not seek nor should we expect housing and related sectors to
return to those pre-recession highs.”

Many expect the Fed will engage in additional purchases of
mortgage-backed securities to drive mortgage rates lower, but Plosser
said while the housing crash destroyed a great deal of wealth for the
average consumer and the economy as a whole, “the losses cannot be
papered over with monetary policy nor should it try to do so.”

The housing meltdown has forced many U.S. households and business
to repair their balance sheets by paying down debt and increasing
savings, a process Plosser said he expects will continue into 2012 —
although the drag on growth from this rebalancing will gradually lessen
over time.

Not surprisingly, a significant risk to his outlook for the U.S.
economy is the continuing sovereign debt crisis in Europe.

Aside from the negative impact on U.S. exports from a slowdown in
the Eurozone, Plosser noted that while strains in financial markets have
been limited to European institutions so far, the situation bears
watching to ensure that there are no adverse spillovers to U.S.
financial institutions.”

“Of course, regardless of how the European situation plays out, it
has already imposed considerable uncertainty on growth prospects for the
global economy,” he added.

That uncertainty, Plosser continued, has been compounded by the
inability of the United States to get its fiscal house in order and on a
sustainable path.

“Until the economic environment becomes clearer, firms and
consumers are likely to postpone significant spending and hiring
decisions — posing a drag on the recovery, even as economic
developments in the U.S. continue to improve,” Plosser said.

** Market News International **

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