By Steven K. Beckner

(MNI) – The Federal Reserve’s two-pronged monetary stimulus program
announced last Thursday is likely to have little positive effect on the
economy, and what few benefits there are will likely be outweighed by
the costs, Philadelphia Federal Reserve Bank President Charles Plosser
said Monday.

Plosser, in an exclusive interview with MNI, said the Fed’s
policymaking Federal Open Market Committee’s should have been “more
patient,” given that household and business spending is being restrained
by forces which monetary policy cannot counter.

The FOMC’s decision to launch a third, open-ended round of
large-scale asset purchases to lower long-term interest rates and to
extend the anticipated period of zero short-term rates run the risk of
higher inflation and other distortions, he warned.

By greatly expanding the Fed’s already bloated balance sheet,
Plosser said the new “quantitative easing” program could strain the
ability of the Fed to tighten monetary policy with untested tools when
the time comes.

What’s more, Plosser warned that the Fed is risking its
“credibility” and the confidence of the public by trying to do things,
such as reducing unemployment, it is not capable of doing.

Plosser also objected to what he called the Fed’s “very dangerous”
effort to increase stock prices and to engage in what he called “credit
allocation” through the purchase of mortgage backed securities. The Fed
would have been better off to buy Treasury securities if it was going to
buy anything, he said.

The FOMC announced last Thursday that it will buy $40 billion per
month of MBS until further notice. Through year-end QE3 will run
concurrently with the “Operation Twist” bond buying program, yielding
total monthly purchases of $85 billion.

The FOMC did not announce an end date. “If the outlook for the
labor market does not improve substantially, the Committee will continue
its purchases of agency mortgage-backed securities, undertake additional
asset purchases, and employ its other policy tools as appropriate until
such improvement is achieved in a context of price stability,” it said.

The FOMC also said it now expects to keep the federal funds rate
near zero “at least through mid-2015,” instead of “late 2014,” and it
said it “expects that a highly accommodative stance of monetary policy
will remain appropriate for a considerable time after the economic
recovery strengthens.”

Plosser had nothing good to say about either part of the FOMC’s
latest effort to stimulate the economy and reduce unemployment, which
Chairman Ben Bernanke called “a grave concern.”

Plosser said he too is concerned about high unemployment, but said
the benefits of QE3 and the extended forward guidance will be “meager at

He said the Fed actions were unjustified because “I don’t think the
economy has changed that much.”

“The economy is clearly not growing as fast as we’d like, but it is
growing,” despite a number of “headwinds,” such as “the uncertainty
firms are feeling about fiscal policy, taxes and so forth,” he said.

“Those are headwinds that are going to be with us for several
months at least,” he said, adding that it would have been better for
the FOMC to “be more patient, wait until early next year and see how
Congress deals with its challenges” and how the situation in Europe
develops “rather than reacting to recent events that were not terribly
startling or surprising.”

Plosser said the Fed is in “conflict” with deleveraging households
which want to save more, while the Fed wants them to spend more.

Americans “want to move consumption from today to the future,” he
said. “They want to save because they’re not as wealthy as they thought
they were because of the bust in house prices. That’s a natural

“But monetary policy, by driving interest rates down, is trying to
discourage them from saving. So we’ve got this conflict between what
consumers want to do and what policy is trying to get them to do.”

Given people’s strong inclination to save, Plosser said “it’s not
obvious that … lowering interest rates a few more basis points is
having a huge effect on consumers desire to save versus spend … .
Until consumers are more comfortable with their balance sheets, their
debt levels, another 10-20 basis points isn’t going to help.”

In fact, he said lower rates may lead many people to save even more
to make up for lower returns.

As for business, Plosser said firms have “lots of cash,” but
“they’re not investing because they don’t know when consumers are going
to start spending again, they don’t know what’s going to happen to the
election and the fiscal cliff and their tax rates. So there’s all of
this uncertainty about the future for businesses, which makes it harder
for them to want to act until there is some resolution of

Plosser said uncertainty also affects households, but “it’s more
dramatic for businesses.”

“Business fixed investment is not that sensitive to interest rates
in the first place,” he continued. “So I don’t think lowering interest
rates a little bit further is going to take all that money that
businesses are sitting on and break it free until some of this
uncertainty is resolved.”

In his keynote address at the Kansas City Federal Reserve Bank’s
annual Jackson Hole symposium, Fed Chairman Ben Bernanke cited estimates
the $1.7 trillion QE1 had reduced the yield on 10-year Treasury
securities by between 40 and 110 basis points and that the $600 billion
QE2 lowered 10-year yields by an additional 15 to 45 basis points.

Bernanke cited other research purporting to show that past asset
purchases “may have raised the level of output by almost 3% and
increased private payroll employment by more than 2 million jobs,
relative to what otherwise would have occurred.”

But Plosser expressed skepticism about such estimates. He said QE1
was done during a “liquidity crisis” — “a different world than we’re in
now.” So he said estimates of the impact of QE1 cannot be applied to how
QE3 might work.

“I don’t believe these are comparable events,” he said. “There are
too many other things going on. We’re not in a liquidity crisis; we’re
not in a financial panic … . Financial markets tend to be working
fairly well. So I think it is risky to assume that the effects are going
to be the same.”

Saying that it expects to keep the funds rate near zero through at
least mid-2015, though designed to encourage more economic activity,
could backfire if people take the FOMC announcement as a signal that
“the economy is going to stink for that long,” Plosser said.

And if people know that rates are going to be kept low for another
three years, many people may take the attitude toward borrowing to
finance major purchases of “what’s the rush?”

“I don’t think it’s going to encourage people,” he said “If it’s
interpreted as the economy is going to be bad for awhile, it makes
policy even less effective.”

While downplaying the benefits, Plosser amplified the costs in
saying QE3 “does not pass the cost-benefit test.”

He acknowledged that he “view(s) the costs as a lot higher than
some of” his colleagues.

“I think monetary policy is taking some very risky actions,” he
said, adding that those “actions that could be very disruptive to the
economy down the road.”

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