By Steven K. Beckner
By buying $40 billion per month, the Fed will be “creating an
ever-larger balance sheet” and will “risk our ability to exit in an
orderly manner,” Plosser continued. “If circumstances arise where have
to act more aggressively to exit that itself could be a disruption to
financial markets and the economy more generally.”
Another potential cost is that “if this has as little effect as I
think it will it puts our credibility and confidence in the central bank
at risk,” he said. “I think we’re creating the impression that we can
control the unemployment rate, but historically that track record is not
Reducing unemployment via monetary easing is “very difficult to do,”
Plosser said. By announcing that it will continue buying bonds and
holding rates down until labor markets improve, the FOMC is “running
the risk of creating the impression that the Fed has more power over the
unemployment rate than in fact it does.”
“When we fail I think the public’s confidence in the institution is
weakened,” he said, and “that can have long-run consequences.”
Plosser also warned that QE3 “could be highly inflationary.”
“I don’t think it would occur immediately,” he said. “Inflation is
going to occur when excess reserves of this huge balance sheet begin to
flow outside into the real economy. I can’t tell you when that’s going
“When that does begin if we don’t engage in a fairly aggressive and
effective policy of preventing that from happening, there’s no question
in my mind that that will lead to lots of inflation.”
Bernanke and other Fed officials have often said that the Fed will
be able to contain the outflow of reserves into the economy and thereby
limit wage-price pressures by raising the rate of interest it pays on
excess reserves. But Plosser said the IOER and reserve draining tools
cannot be relied upon.
“How fast will we have to do that (raise the IOER)?” he asked. “How
rapid will it have to go up? We don’t have a clue. Raising the IOER
where you have a trillion and half or two trillion dollars in reserves,
we have absolutely zero experience with it.”
“We have the tools to do it, but we don’t know the consequences of
the tools,” Plosser said.
“If the IOER doesn’t work and we have to sell assets, MBS, how will
that affect housing?” he asked. “Will we be able to unwind from this at
a pace that doesn’t disrupt the economy?”
Plosser also expressed concern about the FOMC’s declaration that it
will maintain a “highly accommodative” monetary policy stance “for a
considerable time after the economic recovery strengthens.”
He said monetary history shows “the difficulty the Fed always has
getting the turning point right, particularly when it comes time to
tighten … . Our historical track record on that is far from certain.”
The new FOMC “forward guidance” language is open to the
interpretation that the Fed will be even more inclined to overstay an
easy money stance, he said, although he emphasized that the current FOMC
“cannot bind” future committees.
And Plosser was troubled by the open-ended nature of QE3,
particularly since the FOMC did not specify a “reaction function” of
what it will take for the Fed to stop or taper off its MBS buying.
Bernanke said the FOMC will be looking for “sustained improvement in
labor markets,” but Plosser suggested that it too vague.
And he expressed concern that when QE3 fails to have much impact on
unemployment some of his colleagues will want to “double down” and do
even more asset purchases over an even longer period of time. QE3 itself
amounts to “doubling down,” he said.
“How long will we keep doubling down?” he asked. “That risks both
our credibility. Conveying something about the power of monetary policy
that we don’t have undermines our credibility.”
Once there is more certainty about fiscal policy, Plosser said the
economy should grow by at least 3% next year, leading to lower
unemployment. “Waiting until we have a little more clarity about how
things are going to be resolved would be wise.”
One of Plosser’s biggest concerns is the perception that the Fed is
driving interest rates down to push up stock and other asset prices.
Bernanke made no bones about this in his post-FOMC news conference,
saying that asset purchases “affect stock prices” and makes people “more
willing to spend.”
But Plosser took issue with the Fed using lower interest rates to
increase stock prices to increase household wealth and in turn induce
stronger consumer demand. He said that can only work if Fed easing
reduces unemployment, and he doubted strongly that it will.
“Let’s imagine for the moment that unemployment was not a
problem, just for sake of discussion here,” the former University of
Rochester economics professor said. “Monetary policy doesn’t create new
wealth generally … . If you thought that in the short-run there was a
stream of earnings that firms had and you got this little bump to stock
prices, you might get a higher stock price but rates of return of stocks
would fall because all you’ve done is change the discount rate of future
“So if you don’t change future earnings no wealth is created here,”
he continued. “The only way you’re going to increase wealth or improve
the real economy is to the extent that you believe there’s a lot of
slack out there in employment.”
“The only way to add to productive capacity of the economy is to
reduce the slack,” he went on. “So really it works the other way around
in my view. You don’t get a wealth effect from boosting stocks … .
You only get a wealth to extent you reduce unemployment, reduce slack.”
“But if your policy doesn’t do that, if the efficacy of your policy
is such that it’s not going to help very much. then you’re not going to
be creating any wealth,” he said.
Beyond the ineffectiveness of using monetary policy to push up
stock and other asset prices, Plosser had another major objection.
“I’m not inclined, nor do I like to talk about the effects of
monetary policy on the stock markets and wealth, because I worry that we
are creating the expectation that movements in the stock market become
either objectives directly or policy instruments indirectly,” he said.
“I think that’s a very dangerous place for central banks to go,” he
added. “So I do not like us talking about that in this way.”
Plosser expressed the hope that, when the second, $267 billion
“Operation Twist” expires at the end of the year, will reevaluate its
total asset purchase activities.
“That will be a natural time to reevalaute policy,” he said. “We
will have to see where economy is and where my colleagues stand … .
That will be a natural breaking point … . We should take that
evaluation very seriously.”
If Operation Twist is allowed to expire and if the FOMC does not
boost the size of QE3 purchases, monthly bond buying will recede from
$85 billion to $40 billlion.
Asked if the FOMC might then increase monthly QE3 purchase amounts
to prevent a decline in total bond buying, Plosser said, “No doubt there
will be some who will make that argument.”
But he added, “even from their perspective it will depend on what
the economy looks like and what our forecast looks like.”
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