–Need to See Economy Improve, Not Just Avoid Deterioration
–Has ‘Open Mind’ But Favors QE2 If No Improvement

By Steven K. Beckner

Rosengren indicated he expects some downgrading of the November
quarterly, three-year forecast, though not dramatically.

“Since June, depending on which data series you look at, there’s
certainly been incoming data that would say the economy and the forecast
are weaker than we projected in June,” he said, noting that private
forecasters have steadily raised their projections of where the
unemployment rate is likely to be a year end to 9.7%. He said those
private forecasts are “similar to my own.”

Many of his colleagues have downplayed deflation threats, but while
not actually predicting that will happen, Rosengren exhibited a greater
degree of concern. Even disinflation poses a significant threat, he
suggested.

“If disinflation continues you get closer to zero with every
quarter that more disinflation occurs,” he said. “So it’s just an
arithmetic calculation that as you get closer to zero the possibility of
getting below zero goes up.”

Were there to be a “policy mistake,” such as Japan made in 1997
when it withdrew monetary and fiscal stimulus, or if there was some
“shock from abroad,” Rosengren said the U.S. could conceivably be thrown
into deflation. So “the closer you get to zero you are the more
concerned you should be.”

Short of outright deflation, disinflation is already posing a
problem in terms of the degree of monetary restraint on the economy, he
argued.

“If the federal funds rate is fixed at zero and you care about the
real funds rate, well the real funds rate is the funds rate minus the
inflation rate,” he said. “So even disinflation is a tightening because
that means the real rate is going up.”

“Even disinflation, much less deflation, would be an undesirable
outcome at this point,” he added.

Rosengren was not willing to prejudge the type or amount of
quantitative easing, again calling it “situational.”

He said it was “very appropriate” when the Fed first launched large
scale asset purchases last year because “the economy was in a very
different position than it currently is.”

How much Q.E. the Fed should do if it decides to resume it “depends
on an assessment of the economy, and it partly depends on which of the
channels you think are most important to influence.”

“If what you’re trying to convey is that we’re not tightening very
soon, that might be one path,” he said. “If what you’re trying to
convey is that we want to show that further disinflation would be very
undesirable and that was the main thing you wanted to convey you might
pick something different.”

“If instead you were going to use a more traditional interest rate
way of scaling it … you ask yourself, normally we move in 25 basis
points on the funds rate, what would be the equivalent for a long-term
interest rate?”

“Each of these channels may be more or less important depending on
what you’re seeing in the economy,” said Rosengren. “There are
different ways you could go with any particular program.”

“So it’s not only which of these channels is most important, it’s
even which asset would be most effective,” he went on. “It may depend on
what’s happening in the economy and which of these channels is most
important to influence it.”

Some have questioned whether renewed asset purchases would be
effective in the face of tax, regulatory and other uncertainties, but
Rosengren suggested the Fed has little choice but to at least try to
stimulate the economy and combat disinflation, given its statutory
mandate to do so.

“Monetary policy by itself can’t correct all the problems in the
economy,” he said. “But it can mitigate some of the undesirable
effects of a very high unemployment rate and a relatively low inflation
rate,” he said. “No one should expect that monetary policy can
magically get us back to full employment quickly, but what it can do is
get us there more quickly than if we hadn’t done it.”

Rosengren said there are two questions the FOMC must ask: First,
“can we affect interest rates?” And second, “if interest rates are moved
down is it likely to have an impact on the economy?”

Answering his first question, he said, “I’m quite convinced that if
we’re willing to purchase enough assets we can move interest rates.”

Answering the second, he said, “Even if it was less of an impact
than if we didn’t have all these financial dislocations, I know the
direction. I don’t know for certain the magnitude, but if what I’m
trying to move is an economy that is missing on both elements of the
mandate, getting the direction right is an important start.”

“We have a very large (output or employment) gap, but even some
improvement in the gap is better than no improvement in the gap,” he
added.

Rosengren said that “unconventional” monetary measures like Q.E.
are “the only alternative left to us.” He acknowledged there are costs
and benefits to be weighed and said there are “difficult issues” such as
credit allocation, debt monetization and the eventual exit from an
expanded balance sheet, but he said “just because it’s a difficult issue
doesn’t mean we shouldn’t do it.”

“Our mandate doesn’t give us an exemption for once you hit the zero
bound you no longer have to worry about your mandate,” he said.

Aside from asset purchases, Bernanke mentioned the possibility of
using its communication to extend the market’s expectation of how long
the Fed will hold rates down and/or cutting the IOER. But Rosengren
sounded dubious.

“Right now, I don’t perceive there being a communication problem,
and I think the impact of (cutting) interest on reserves is more than
likely to be fairly limited.”

That leaves Q.E. as the most effective tool, and Rosengren left no
doubt he favors that approach if the economy doesn’t improve soon.

“Right now, large asset purchases are considered because I think
the communication is relatively straightforward, at least on what we’re
doing,” he said. “There is some issue as to exactly what the strategy is
behind that, but I think we can be clear on that over time.”

“We’ll just have to decide at each of the meetings whether market
expectations and other factors make one tool or another the most
effective way to have an impact on the path we’re trying to achieved,” he
said.

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** Market News International **

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