–Retransmitting Second Section of Story Published 8:15 ET Wednesday

By Steven K. Beckner

Plosser said he “would like to see us discuss more rule-based
strategies; talk about the trade-offs of different rules; talk about
their behaviors; talk about what alternative rules tell us about
performance and not just pick two numbers.”

Picking two indicators is “not a rule,” he said. “That’s just a
point. And I think how you pick that point — where that point comes
from — has to involve a discussion of the rules.”

Using a “robust rule,” the FOMC “may put different weights on the
output gap and inflation gap,” Plosser said. “It may be in terms of
growth rates, rather than levels, changes in the gaps as opposed to the
levels of the gaps.”

“And so what it does is (ask) are there specifications of the
Taylor rule, variations on the theme if you will, that work well when
you have a lot of uncertainty about the model,” he elaborated. “And
clearly, people do disagree about the model. We use models a lot, but
everybody doesn’t have the same one necessarily. So having a rule or
guideline that works well in a variety of models would be appealing.”

Considering some “robust rule” to guide rate decisions is “a
promising avenue to go down, because again if we’re not sure about the
model we want to look at versions of rules that perform well in a variety
of models, and that would be a good thing to do,” Plosser said. “There
are various versions that people have proposed, and I think more
investigation and thought of those that might work well for us would be
a healthy discussion to have.”

“If we could agree on something it would improve our ability to
communicate immensely,” he added.

Plosser said it “may not have to be” complicated to communicate
such a strategy.

The former University of Rochester professor and Shadow Open Market
Committee member took strong exception to using communications as just
another monetary stimulus tool, however.

“I think that’s the wrong reason to change communications at this
point,” he said. “My concern would be to have a better communication
plan that describes our inflation objectives and the way we’re going to
conduct policy.”

“If that ultimately implies that rates will be lower longer then so
be it,” he said, but “that’s an outcome, not an objective.”

“If someone were to say that ‘I already believe that I want to keep
rates lower longer, and I just have to figure out a way to convince
people that’s what I want to do … that’s the wrong way to conduct
policy,” he continued. “It’s a means rather than an end.”

Those “who want a different set off communication strategies and
frameworks so we can rationalize keeping rates lower longer” have it
“backwards,” he went on. “That’s the backwards way to do the analysis
from my perspective, because that way you’ve already assumed what the
answer is; you just want a rationale for how to deliver it. That’s not
the way to think about it.”

“Now, if we can get an understanding of a rule that constitutes
good policy that may be an outcome of that,” he said. “But you don’t
make rules out of convenience that you’re free to violate whenever you
want to because it doesn’t suit you. That’s not the way to think about
systematic policy.”

Plosser also expressed strong discomfort with Operation Twist — in
particular with the impression it creates of a central bank trying to
help the Treasury hold down its borrowing costs. He argued that the Fed
is endangering not only its credibility, but also its independence when
it buys large amounts of long-term Treasury securities.

“Central banks, particularly the Fed, … for better or worse, have
become very intertwined in fiscal policy,” he said. “We need to look
for ways to separate ourselves from fiscal policy more clearly, create
a new bright line if you will, because the more we’re engaged in fiscal
policy the more we put at risk our independence because we’re stepping
on the toes or venturing into the arena of the fiscal authorities.”

“We have to seek ways to distance ourselves from fiscal policy and
stick to things that are traditional monetary policy,” he said.
“Otherwise we undermine or put at risk our independence and put at risk
the credibility of the C.B. to do the things it can actually do vis a
vis price stability.”

Far from distancing itself from fiscal policy, Plosser suggested
the Fed is getting even more involved. As an example he cited the $400
billion “Operation Twist.”

“It’s purely debt management,” he asserted, adding that “the
Treasury could do it all by itself.”

The Treasury “could issue less long-term and more short-term debt,”
he said. “It would accomplish exactly the same thing the Fed is doing.
We’re buying up long-term debt and selling short-term in operation
twist. The Treasury could do that on its own. It doesn’t need us to do
that. So that’s pure fiscal policy.”

Although other Fed officials have said it is not the intent of the
Treasury to help it hold down the cost of financing record deficit
spending, Plosser scoffed.

“The intent was to lower long-term interest rates,” he said. “When
you lower long-term interest rates, you lower it for everybody. However,
to the extent people thought it would work, it lowered them mostly for
the Treasuries. The evidence we had from the 60s is that it didn’t lower
it much for business and consumers. The basis point reduction was far,
far less.

“So in some sense what we’re doing is debt management on behalf of
Treasury,” he said.

Plosser suggested the Fed is risking its independence and
credibility for very little economic benefit.

Long-term yields plunged after the FOMC announced Operation Twist
on Sept. 21, with the 10-year yield going as low as 1.71%, but it has
since risen back to 2.18%.

Plosser said it is impossible to know whether rates would are lower
than they otherwise would be thanks to the Fed’s bond buying. He said
even its advocates thought the yield impact would be no more than 20
basis points, and “the daily standard deviation of bond yield is 10
basis points, so we’re talking about having effects that are just
swamped over time by other factors.

What’s more, “even if we believed the effect was going be 20 basis
points and that turned out to be true … the effect (on consumer and
business borrowing rates) is much less than that,” he said, so “it’s
hard for me to believe it’s going to have much impetus to business
borrowing, consumer spending or employment.”

Besides, Plosser argued, ever lower interest rates are not the
medicine needed by an economy facing barriers to growth which monetary
policy can’t address.

He said the economy is being held back not only by the ongoing
housing slump and continued household deleveraging, but also by
tremendous uncertainty about fiscal policy, tax rates and an array of
government regulatory initiatives.

Firms in his mid-Atlantic district tell him they are “frozen in
place until there is a resolution of the uncertainty….,” he said. “I
hear that over and over and over again.” He said a resolution of tax
and regulatory uncertainty “would improve the (business) environment in
a significant way.”

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