By Steven K. Beckner

SANTA BARBARA, California (MNI) – Three Federal Reserve Bank
presidents broadly representing the spectrum of monetary policy opinion
agreed Thursday that there are conditions in which additional
large-scale asset purchases would be appropriate but differed on just
what those conditions would be.

The trio of Fed policymakers put varying degrees of emphasis on the
pace of economic growth, the level of unemployment, the rate of
inflation and threats from abroad, particularly Europe.

The three — Atlanta’s Dennis Lockhart, Philadelphia’s Charles
Plosser and San Francisco’s John Williams — concurred that the Fed’s
bloated balance sheet and bank reserves do not pose a direct threat of
higher inflation — provided the Fed raises the rate it pays on excess
reserves (the IOER) in a timely way once stronger bank lending begins to
draw reserves out of the Fed and into the economy.

Plosser warned that shrinking the balance sheet, when that time
comes, could be tricky and politically sensitive, while Lockhart
predicted that, even once the Fed implements its “exit” from its very
accommodative monetary policy, the Fed balance sheet will be much larger
than it was before the financial crisis hit and led the Fed to take
actions that more than tripled it.

Their remarks came in cordial interaction at a press conference and
in response to audience questions following an “economic summit”
sponsored by the University of California-Santa Barbara.

MNI asked the three to differentiate among themselves how they see
the triggers for a third round of quantitative easing or QE3.

Williams, a voting member of the Fed’s policymaking Federal Open
Market Committee, replied that he would favor QE3 if he saw “a sustained
movement away” from the Fed’s 2% price stability objective, such as
threatened when he Fed launched QE2 in November 2010.

“On the economic side,” Williams said he would want to see the
country “continue to make steady progress on the unemployment
objective.”

“If we really saw the economy stalling so that unemployment was
just stuck … over some months … that’s those are the kind of signals
that would raise the probability of doing further stimulus,” he added.

At the same time, the reputedly “dovish” Williams made clear he is
not eager to launch QE3, telling the audience that “right now our policy
is correctly calibrated.”

But “if the economy stalled, if unemployment got stuck around
current levels or we saw very low inflation … then it’s natural to say
we need to have more monetary stimulus.”

On the other hand, “if the economy really takes off and inflation
moves out further we would need to remove accommodation earlier,” he
said.

The non-voting Plosser is considered to be on the other end of the
policy spectrum, but he said he too would support QE3 in the kind of
circumstances Williams described. He emphasized, however, that a
stalling of growth and unemployment and excessive disinflation are “not
in my forecast.”

“As long as the economy is growing and inflation is near target I
would not find QE3 a good policy choice when I weigh the costs and
benefits,” said the hawkish Plosser.

But he added, “there are environments when we may have to do more,”
he added, citing as examples a situation in which there was a European
financial “implosion.”

“We would have to react to that,” said Plosser, adding that the
FOMC “would have to act” “if inflation were to (fall) a lot lower and we
were worried about maintaining our inflation objective of 2%.”

In between the “dovish” Williams and the “hawkish” Plosser, the
more middle-of-the-road Lockhart once more took a cautious approach to
QE3.

In response to MNI’s question, he said economic “conditions are
quite different today” than they were in November 2010 when the Fed
launched QE2. Then, inflation was “falling fairly rapidly” and “there
was a reasonable concern about going into a deflationary situation.”

Now, in contrast, “we do have moderate growth, inflation is at a
pretty stable level and unemployment is coming down gradually,” he said.

Lockhart, while not eager for QE3, told the audience he “wouldn’t
rule it out.”

He said the FOMC should “hold it in reserve” in case “there’s a
marked deterioration in the economy” with “rising unemployment” and the
economy “heading in the direction of deflation.”

Although he did not specifically cite it as condition for QE3,
Williams expressed strong concern about Europe, warning that he could
see a “real panic” coming in the euro zone.

He said it is putting it too nicely to say of Europe’s debt burden
that it is merely “kicking the can down the road.” A more apt analogy,
is that of a snowball “getting bigger and bigger.”

The three were asked about the inflationary implications of the
Fed’s balance sheet, which has grown from $800 billion in 2007 to nearly
$3 trillion.

Lockhart said that this does not represent “high-powered money” or
“money out in the economy,” but “sidelined money.”

He said the Fed has the “ability to drain reserves … at the
appropriate time,” although he said the balance sheet will likely end
permanently larger “for a variety of reasons,” including banks’ desire
to hold larger excess reserves.

Plosser agreed the unprecedented expansion of the balance sheet
does not pose an immediate inflationary threat, but he said it could
become one if the Fed fails to drain or immobilize reserves sufficiently
quickly. He said the Fed may have to do so aggressively.

But “we’ve never been here before,” he emphasized, and the question
must be asked “what will be the consequences for the economy if we have
to sell assets …. That could be a challenge for the Fed if the economy
is not growing as fast as we’d like.” He suggested there could be
political resistance.

Williams echoed his colleagues in saying that the large amount of
bank reserves is “not money circulating in the economy.”

“More importantly we’ve changed our operating procedure,” he
stressed, noting that the Fed now pays interest on excess reserves and
can thus incentivize banks to hold reserves at the Fed rather than
increase lending by raising the IOER. “Basically we have a corridor
system of monetary policy like many other central banks.”

So “it’s not the case that there’s any economic, causal or even
empirical relationship between the size of the balance sheet and how
much money is out in the economy,” said Williams, adding that if it
wishes the Fed can continue to have a large balance sheet “as long as
we’re raising the IOER.”

“It doesn’t in any way imply inflation,” he added.

Plosser agreed that the expanded balance sheet will only pose an
inflation risk “when reserves get into economy,” and that the Fed can
prevent that by hiking the IOER.

But he warned, “it’s always simpler to ease than to tighten.” And
he warned of a political “hue and cry” when the Fed sells assets or
raises rates.

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

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