–Large-Scale Asset Buys Can Be Effective But Need More Analysis

By Brai Odion-Esene

WASHINGTON (MNI) – Cleveland Federal Reserve Bank President Sandra
Pianalto Monday said she is in favor of the central bank taking actions
to support the recovery that have economic benefits “with manageable
risks.”

In prepared remarks to the Central Ohio Business Luncheon in
Newark, Ohio, Pianalto said large-scale asset buys — commonly referred
to as quantitative easing — can be effective, but the Fed’s limited
experience with such non-traditional policy tools means more analysis is
needed.

She also stressed that “it takes time for our monetary policy
actions to affect the economy, so our policy decisions have to be
forward-looking.”

Pianalto, a key swing voter on the Fed’s policymaking Federal Open
Market Committee this year, is in the camp of the more cautious monetary
policymakers — who tend to avoid coming out publicly in favor of one
policy action over another. They also usually reserve judgement on
whether aggressive monetary stimulus is needed until the day of the
meeting.

Although the current “remarkably unusual” economic environment
calls for highly accommodative monetary policy, Pianalto noted that
“even with the aggressive and extraordinary actions that the FOMC has
taken, we remain in a frustratingly slow economic recovery.”

Many have urged the Fed to include purchases of mortgage-backed
securities in any third round of quantitative easing in order to provide
more of a boost and ameliorate conditions in a still struggling housing
market.

Pianalto acknowledged that the Fed’s unconventional policies in the
past have served its purpose of further easing monetary conditions to
support the recovery, while noting separately that the housing market
“has been a key barrier to a stronger expansion.”

Still, with the debate raging on over whether the Fed ought to do
more or hold off, Pianalto made clear that “I am supportive of actions
that provide economic benefits with manageable risks.”

Large-scale asset purchases can be effective, she said, but the
Fed’s experience with these programs is limited, and as a result, they
justify more analysis.

“For example, as the structure of interest rates has moved lower
over time, it is possible that future large-scale asset purchase
programs will yield somewhat smaller interest-rate declines than past
programs,” she said. “A related issue to evaluate is whether further
reductions in longer-term interest rates would stimulate economic
activity to the same degree as they have in the past.”

She stressed that a stronger economic expansion will require
significantly more support from consumers and businesses but noted the
weight on sentiment from — and the risks posed by — Europe and
near-term issues with U.S. fiscal policy.

She forecast the U.S. economy to grow by about 2% this year,
meaning slow improvement in the stubbornly high jobless rate.

And while Pianalto sees inflation staying close to the Fed’s 2%
target, the pace of GDP growth should pick up gradually through 2014,
she predicted, with the unemployment rate above 7% through 2014.

She noted that housing is showing signs of improvement, with
indications that an uptrend has emerged this year.

Although Pianalto is of the opinion that monetary policy should do
what it can to support the recovery, she cautioned that there are limits
to what monetary policy can accomplish.

She also delved further into the potential costs of another round
of QE, echoing concerns voiced by some FOMC participants as indicated in
the minutes from the group’s August meeting.

Pianalto warned that, at some point, policies designed to promote
further declines in rates could interfere with financial stability, with
the low interest rate environment pushing banks to take excessive risks.

“At the same time, financial companies could keep prudent credit
standards but still suffer significant losses if they were holding too
many fixed-rate, low-yield assets when market rates began to rise,” she
said.

Pianalto would also not rule out the possibility that the Fed’s
foot print in certain securities markets would become so large that it
would distort market functioning.

“It is important to have good estimates of how large the Federal
Reserve’s participation would have to be to cause a meaningful
deterioration in securities market functioning, and to better understand
the potential costs of such deterioration for the economy as a whole,”
she said.

** MNI Washington Bureau: 202-371-2121 **

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