By Steven K. Beckner


“If the Fed got to be too big a buyer in that market, so that it
ended up being nearly the only buyer in that market there would be
worries and concerns about does that disrupt the functioning of an
important part of our financial markets,” he said. “So we’re being very
careful not to get to be such a dominant player that we’re affecting
market functioning too much.”

“So that would be an argument for putting some kind of cap … on
increasing MBS purchases significantly further,” he added. And it might
be an argument for buying long-term Treasuries, rather than MBS, if the
FOMC decides $40 billion is inadequate.

He said Treasury “market functioning seems to be fine.” And even
though the Fed is “a big holder of long-term Treasuries … that’s a
huge market.”

“So I think we could increase our purchases of longer term
Treasuries or say continue buying the $45 (billion),” he said. “We’re
buying them now (in the MEP), and we could continue doing that without a
concern for market functioning.”

“If we really needed or wanted to, if it was appropriate to buy
more longer term assets starting in January, I think there is an
argument for doing a mixed strategy where we continue to buy mortgage
backed securities but add longer term Treasuries in to that mix,” he

But he said the FOMC would have to do “a pretty careful analysis of
both the benefits of these various tools, which I think of as being
roughly in the same ballpark, but also the costs in terms of how they’re
affecting market functioning and any other effects they have.”

One thing that should not cause the FOMC to increase the size of
QE3 in January is the so-called “cliff effect” of ending the MEP
purchases at the end of December, in Williams view.

“The concern about cliff effects has clearly been in our minds the
last few years,” he said, but “what we learned from our previous
programs — QE2 but also watching the MEP as it was running — is that
the market seems to react mostly to the stock of purchases, not only the
announcement of how much we were going to buy but also how much … is
out there being traded, not being held by the Fed or other people…”

“So really what effects market is … the state of supply and
demand and not the flow of how many purchases we’re making in a
particular week or month or these cliff effects,” he continued. “So what
we’ve learned is these cliff effects or flow effects of stopping a
program have not ended up being much of an issue at all.”

Williams said concerns about the impact of Operation Twist’s
expiration “really aren’t reason, would definitely not be a reason to
modify the purchase program in the future.”

“I think we were pretty comfortable with the MEP expiring at the
end of the year and not having that cause any disruptions or any
particular effects on rates, because of course we continue to hold the
instruments that we bought or the securities we bought,” he added.

Williams said he “would expect to see the market react quite a bit
if we started selling” securities, but “even if we stop buying them, as
long as we hold them, we don’t see any cliff effects.”

The larger issue is what the economy does, he emphasized.

“Really to me the question of whether in January we should continue
the MBS purchases or whether we should continue buying longer term
Treasuries or change the mix of that, the amount of that, all that is
really driven by the macroeconomic situation,” he said.

“As the FOMC statement says, we’ll focus on seeing substantial
improvement in the outlook for the labor market,” he continued. “So
those are things that are going to be right at the top of the list.”

To determine whether more or less asset purchases are needed, he
said he and his FOMC colleagues will be asking, “Are we seeing
substantial improvement in the economy broadly — thinking about the
broadest measures of economic growth, labor market conditions?

“And it has to be a substantial improvement and it has to be one
that is sustained,” Williams stressed. “It’s not just a couple of months
of good data; it’s really that we think the economy has gained
significant momentum … . Those are the issues that will determine the
asset purchases, all the decisions abouts asset purchases.”

What might cause the Fed to taper off or end its asset purchases,
MNI asked.

Williams acknowledged that the phrase “improve substantially” does
not give a specific, quantitative guideline for what the FOMC will do.
It will be a matter of judgment, he suggested.

“There are different ways to think about substantial improvement,”
he said. “It’s something we have to view as being sustained,
economically significant.”

When he and his FOMC colleagues were working on the FOMC statement,
Williams said “it was a lot easier to define what it (substantial
improvement) isn’t than what it is. And one thing it isn’t is what we’ve
seen over last six or seven months … . We haven’t shown the kind of
sustained substantial improvement that would reflect an economy that has
self-reinforcing momentum that over time is going to bring unemployment
measurably over time to the long-run goal.”

But Williams said that “if we did see significant ongoing strength
in terms of the job numbers, in terms of the GDP, the unemployment
rate … and if we saw that continuing in the future looking at the
outllook, I think that would be a time when you thought about adjusting
— either dialing back on the program or bringing these specific programs
to an end.”

Various observers, including some Fed officials, have expressed
concern about the FOMC’s declarations that “a highly accommodative
stance of monetary policy will remain appropriate for a considerable
time after the economic recovery strengthens” and that it buy MBS
indefinitely until it sees “substantial” labor market improvement.

The fear in some quarters is that the Fed will overstay a lax
credit stance, engendering higher inflation.

But Williams said nothing the Fed said should be interpreted as
signalling a greater tolerance for inflation.

Part of the problem, he suggested, is a matter of emphasis. When
inflation was running well above 2% in the 1970s and 1980s, “we talked a
lot about inflation,” he recalled, but for 20 years the Fed has been
successful in keeping inflation at around or even under 2%, its target.

Meanwhile, unemployment, at 8.1% in August, is running well above
the FOMC’s longer-run projection of 5.2% to 6%, and Williams said he is
“not seeing signs of the economy gaining the kind of momentum we need
for us to reach our mandate goals of maximum employment and price
stability in a reasonable period of time.”

And so, “it’s natural, given that unemployment is so high yet
inflation is more or less where we want it to be focused on unemployment
and what can monetary policy do to improve employment, he said.

“I don’t view the statement language at all as reflecting a shift
or a change … about the weighting of goals or what our goals are,”
he said, adding that the FOMC statement last week is “completely
consistent” with its January agreement of longer term goals and our
strategy, in which the FOMC enunciated a “balanced approach” to
achieving maximum growth and price stability.

Williams said the Sept. 13 statement “reflects the fact that we do
want to keep a balance between our two objectives. And that means that
sometimes inflation will be a little bit higher than 2%. Sometimes it
will be lower 2%. What we’re trying to do is keep average around 2% and
close to 2%.”

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** MNI **

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