By Steven K. Beckner
(MNI) – Brian Sack, head of the New York Federal Reserve Bank’s
open market desk, opined Monday that increased Fed purchases of
securities would be effective in lowering long-term interest rates and
providing monetary stimulus to the economy.
Sack, speaking at a CFA Institute Fixed Income Management
Conference, said the Fed’s policymaking Federal Open Market Committee
will need to weigh the costs and benefits of renewed quantitative
easing, but strongly suggested that, in his view, the benefits outweigh
the costs.
If the FOMC decides to go beyond current purchases of Treasury
securities, designed to keep the Fed’s balance sheet from shrinking, and
authorize the open market desk to expand the balance sheet, Sack
suggested five disiderata that should go into the design of any new
“QE2″ program of securities purchases.
The New York Fed Executive Vice President suggested that bonds be
bought in smaller increments than in QE1; that purchase timing and
amounts should be more governed by how the FOMC forecast evolves than in
QE1; that resulting increases in balance sheet be “persistent;” that the
Fed communicate the likely path of the balance sheet, and that expanded
asset purchases should be conducted with “flexibility” and “discretion.”
Sack left the door open to further purchases of mortgage-backed
securities, although the Fed is now reinvesting proceeds of maturing MBS
in Treasury securities.
New York Fed President William Dudley, on Friday, made clear he is
leaning toward supporting QE2, saying it is “likely” to be needed, and
Sack echoed those sentiments.
He said “the sluggish outlook for the economy and the risks that
surround that outlook have raised the possibility of further monetary
policy accommodation,” and he went on to suggest that expanded
securities purchases would be worthwhile.
“In my view, the evidence suggests that the expansion of the
securities portfolio to date has helped to foster more accommodative
financial conditions, and further expansion would likely provide
additional accommodation,” he said. “Of course, whether the FOMC decides
to take such a step will be determined by its assessment of whether the
benefits of additional policy stimulus outweigh the perceived costs of
expanding the balance sheet.”
Sack said “balance sheet expansion appears to push financial
conditions in the right direction, in that it puts downward pressure on
longer-term real interest rates and makes broader financial conditions
more accommodative.”
He acknowledged concerns that, even if they further lower long-term
interest rates, expanded securities purchases “will not affect the
economy because the transmission mechanism is broken.” But he disputed
such contentions.
“This point is overstated in my view,” he said. “It is true that
certain aspects of the transmission mechanism are clogged because of the
credit constraints facing some households and businesses, and it is true
that monetary policy cannot directly target those parties that are the
most constrained.”
“Nevertheless, balance sheet policy can still lower longer-term
borrowing costs for many households and businesses, and it adds to
household wealth by keeping asset prices higher than they otherwise
would be,” he continued. “It seems highly unlikely that the economy is
completely insensitive to borrowing costs and wealth, or to other
changes in broad financial conditions.”
Addressing other concerns, Sack contended, “In the current
circumstances, there would seem to be room for the Federal Reserve to
expand its holdings of Treasury securities without creating difficulties
for market functioning.”
“Any purchase program that the FOMC decides upon, whether aimed at
Treasury securities or MBS, would be designed to support market
functioning as much as possible while still achieving the programs
economic objectives,” he added.
Nor was he worried that expanding the balance sheet would
complicate the Fed’s ability to eventually shrink it and tighten policy
to prevent inflation.
“I am confident that our ability to exit will not be compromised by
any further expansion of the balance sheet,” he said.
“The exit strategy that is ultimately implemented will have to take
into account the size and structure of the balance sheet at that time,”
he went on. “However, in all potential circumstances the Federal Reserve
should be able to tighten financial conditions to a sufficient degree
when appropriate.”
“The ability to pay interest on reserves, in combination with the
ability to drain reserves as needed, will give us sufficient control of
short-term interest rates,” he said, adding that “both of the Fed’s
reserve draining tools — the reverse repurchase program and the term
deposit facility — are already operational, and their capacity to drain
reserves will continue to expand.”
“In addition, the Federal Reserve could always sell assets to
reduce the size of its balance sheet if it desired,” Sack said.
Sack will play a key role in designing a QE2 program as a top
advisor to FOMC Vice Chairman Dudley. If the FOMC decides to expand the
balance sheet, he said it “would presumably want to take into
consideration the perspective gained from the asset purchases conducted
from late 2008 to early 2010.” But he said it may also want to “design a
purchase program that shares more of the features of the FOMC’s
adjustment of the federal funds rate in normal times.”
“After all, adjustments to the balance sheet are in many respects a
substitute for changes in the federal funds rate,” he noted. “Both
instruments attempt to influence broader financial conditions in order
to achieve a desired economic outcome.”
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