–If Don’t See Benefits, Don’t Infer Asset Purchases To Be Expanded
–Remains ‘Skeptical’ Of Stimulative Effects Of QE2
–3% To 3.5% Growth Next 2 Yrs; Unemp At 8% To 8.5% By End of 2011
–Expects Inflation To Head Back Towards 2% In 2011 As Recov Continues

By Brai Odion-Esene

ROCHESTER, NY (MNI) – Philadelphia Federal Reserve Bank President
Charles Plosser made it clear Thursday that if the U.S. economy should
experience faster-than-expected growth going forward, the Fed
policymakers should consider curtailing its program to purchase up to
$600 billion of long-term government debt.

He added that should evidence suggest the Fed’s new round of asset
purchases is not delivering its intended benefits, “that policy must be
adjusted to foster our long-run goals.”

In remarks prepared for the 32nd Annual Economic Seminar sponsored
by the Simon Graduate School of Business in Rochester, Plosser warned
that if the expected benefits from the Fed’s new round of asset buys
does not become manifest, “I would not infer that we merely need to
increase the size of the program.”

“Rather, I would take this as evidence that we need to rethink the
analysis of costs and benefits that led us to this policy in the first
place,” he said. “If the economy grows more quickly than I currently
anticipate, the purchase program will need to be reconsidered and
perhaps curtailed before the full $600 billion in purchases is
completed.”

On the other hand, Plosser continued, “if serious risks of
deflation or deflationary expectations emerge, then we would need to
consider whether expanded asset purchases should be used to address
these risks.”

If the FOMC does decide to more asset purchases, Plosser said it
would need to clearly communicate that this step is being taken to
combat deflation and deflationary expectations, and not as an action to
speed up the recovery.

After all, the Philly Fed president said he is still “somewhat
skeptical” that there will be much of a stimulative effect from the new
round of purchases. He said the first round of asset purchases had an
effect because they were done at a time when financial markets were
highly disrupted and asset risk premiums were extremely elevated.

“But markets are no longer disrupted, so we cannot expect the same
effect this time,” Plosser warned.

He added that not only is it not clear that the program will do
much to speed up the improvement in the unemployment rate to more
acceptable levels, but if asset purchases don’t do much to accelerate
aggregate demand, then the argument that the program will reduce the
risks of deflation is also substantially weakened.

“Thus, I think that the benefits of the purchase program may be
modest,” Plosser said, adding that one cost of expanding the Fed’s
balance sheet is that it will complicate its exit strategy — when the
time comes — from a very accommodative monetary policy.

In addition, Plosser said the Fed also faces interest rate risk by
purchasing these long-term government securities. He said if rates go up
and the Fed were forced to sell the bonds in order to prevent inflation,
the Fed would take a loss — as would the Treasury, since the Fed would
not be able to remit as much income back to the Treasury as it otherwise
could.

“Thus, the public bears the same risk exposure whether the policy
is conducted by the Fed or the U.S. Treasury,” he said.

Plosser predicted that due to the forward-looking nature of
monetary policy, the Fed will need to begin removing policy
accommodation before the unemployment rate has returned to an acceptable
level in order to avoid overshooting — which would result in greater
instability in the economy.

He also repeated the argument that while the high level of excess
reserves is not inflationary now, as the economic recovery strengthens,
the Fed must be able to remove or isolate these reserves to keep them
from becoming “the kindling that could fuel excessive inflation.”

“To address this looming challenge, the Fed is developing and
testing tools to help us prevent such a rapid explosion in money. But,
of course, we won’t know for certain how effective these new tools are
until we need to use them in our exit strategy. Nor do we know how
rapidly or how high we may need to raise rates,” Plosser said.

Plosser also gave his outlook for the U.S. economy heading into
next year, projecting GDP growth will be around 2.5% for this year and
will pick up to 3% to 3.5% percent annually over the next two years.

“I do expect continued improvement in economic conditions that will
support moderate growth going forward … . But for now, I expect
moderate growth overall, with strength in some sectors offsetting
weakness in others,” he said.

Housing is one sector that he expects to remain weak for a while
longer. On the other hand, Plosser expects business to continue making
fixed investments at “a healthy pace” over the coming year.

As for the consumer, Plosser said noted that although households
are now in the process of shoring up their balance sheets, with
unemployment remaining “stubbornly elevated” aggregate wealth will
recover only slowly. This means there will not be a stronger rebound
without more improvement in the labor markets.

With the U.S. Labor Department set to release non-farm payrolls
data for November Friday, Plosser said he expects to see improvement in
labor markets, but that improvement will be a gradual one.

“I expect the unemployment rate will fall to around 8 to 8.5%
percent by the end of next year,” he said. He added that the contraction
in the real estate sector and in sectors closely related to residential
construction, such as mortgage brokerage, mean that many workers will
likely need to find jobs in other industries “and this will take time.”

Regarded as one of the more hawkish officials with the Federal
Reserve, Plosser did not disappoint in his remarks, saying that while he
does expect inflation will be subdued in the near term, there is no
significant risk of a sustained deflation.

“While inflation is currently lower than the 1.5 percent to 2
percent level many monetary policymakers would like to see, it does not
follow that sustained deflation is imminent or even likely,” he said.

Plosser concluded that, as the recovery continues, he projects that
inflation will return toward 2% over the course of the next year.

** Market News International **

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