By Steven K. Beckner

BOSTON (MNI) – Boston Federal Reserve Bank President Eric Rosengren
said Saturday that Japan’s experience with combatting deflation shows
that an “active,” rather than “gradual” monetary policy response works
best.

Because deflation is “pernicious” and hard to eradicate once it
takes hold, he said it is best to take out some “cheap” insurance
against it.

Rosengren, a voting member of the Fed’s policymaking Federal Open
Market Committee this year, extolled the benefits of quantitative easing
on long-term interest rates, but did not specifically advocate doing so
at the Nov. 2-3 FOMC meeting.

He acknowledged that reducing market interest rates through
quantitative easing will have an impact on the value of the dollar, but
said that is a potential “channel” in which Q.E. will work.

Rosengren, in remarks prepared for a Boston Fed conference, drew
several lessons from the Japanese experience:

— “First, should deflation occur, it can be quite difficult to
overcome.

— “Second, insuring against the risk of deflation may be much
cheaper than waiting until it has occurred and then trying to address
it.

— “Finally, financially fragile economies may be particularly
vulnerable to negative impacts from premature austerity measures.”

Rosengren cited studies showing that Q.E. tends have “an impact on
mortgage rates in the range of 25 to 100 basis points.”

“Thus, I think the empirical evidence supports the view that an
LSAP program can influence the market rate of the asset being
purchased,” he said. “Certainly the impact may be influenced by the
economic and financial conditions at the time of the announcement and
purchase.”

But he said “the scale of the program should be sensitive to the
prevailing conditions, and the size of the program would need to vary to
accomplish a particular interest rate outcome.”

Addressing the impact of Q.E. on the dollar, Rosengren said many
factors affect the value of the currency, but said, “Nonetheless, one
might think that the exchange rate would be influenced by policies to
reduce domestic interest rates as investors move funds to countries
yielding a higher return.”

He said “this is a channel worth studying and better
understanding.”

Another potential channel through which Q.E. could work, he said,
is bank lending.

“As large corporations issue long-term debt at attractively low
rates, they become less dependent on loans or lines of credits from
banks,” he said. “As larger firms move to capital markets for financing,
it should free up bank balance sheets to allow a focus on those firms
that really depend on banks for financing.”

Rosengren drew several conclusions from the Japanese experience:

— “First, a policy of gradually adjusting monetary and fiscal
policy, as conducted in Japan after deflation first occurred, may not be
as effective as an active policy response taken before deflation has
become embedded in the economy….

— “Second, while monetary policy may have difficulty fully
offsetting a severe shock when the zero bound is hit, there are still
important channels for monetary policy to use to mitigate the negative
shocks.

— “Third, it is not a coincidence that in Japan, the United
States, and Europe these economic problems have been encountered in
conjunction with banking and financial market problems.

— “Finally, we all recognize that conducting unconventional
monetary and fiscal policy at the zero bound requires political will.”

** Market News International **

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