By Steven K. Beckner

Acknowledging the possibility that the economy could recover faster
than projected, Bullard said “that’s why you want to be state
contingent. You want to maintain some flexibility, because if the
economy is going to roar back all by itself, that’s great news and then
we should be able to pull back this program back or put some limits on
the program and adjust.”

In determining whether more or less quantitative easing is needed,
Bullard said the FOMC has set itself no numerical goals for
unemployment, interest rate levels or other indicators.

“I don’t think there are trigger points,” he said. “It will have to
be a judgment by the Committee as a whole as to whether we’re making
faster progress toward our mandated goals.”

“Of course, we are making progress toward our mandated goals, but
it’s inching along,” he continued. “It will take a long time to get back
to normal. So I think the thinking is if we can speed up that process a
bit that will be better for us and better for the economy.”

Bullard said he would be “loathe to go too far here and end up with
an episode where inflation really gets out of control. So I think we
will pay particular attention to those risks and see how they look going
forward.”

Bullard reiterated that “there are no magic numbers” for
determining success or for adjusting the size of QE2. “It’s about the
Committee’s judgment about the pace at which we’re getting back to a
more normal situation for the U.S. economy, because I think everyone
understands at this point that unemployment is still going to be high
for a while and probably inflation probably will remain below our
implicit inflation target for awhile.”

“But if we feel like we’re going in the right direction and we’re
going at reasonable pace, I think that’s the kind of judgment the
Committee has to make,” he went on. “And there is certainly no agreement
on specific numbers or specific triggers or anything like that.”

“So it’s going to have to be debated out and it’s going to have to
be a Committee-wide judgment about whether we’re being more successful
in those dimensions than we were,” he added. “But it’s the pace that we
return to inflation at target and output at potential.”

The New York Fed said last Wednesday it “anticipates that the
assets purchased will have an average duration of between five and six
years.”

Asked about the rationale for that maturity, Bullard said the FOMC
was not “as sensitive to that as the (open market trading) Desk is.” He
said the Desk “wanted to be able to give some guidance to the market
players as to exactly which (issues) they would be most active in.”

He said the FOMC “partially delegated to the Desk to let them tell
us what the best way to operate is” just as the FOMC has never tried
to “micromanage the Desk operations” when it comes to pegging the
federal funds rate.

But Bullard suggested that, like the total size of QE2, the average
duration could change as the program goes forward.

“I think as a basic premise the idea would be that very short rates
are at zero and you can sort of gradually move out the curve,” he said.
“It probably makes more sense to go that way than to go all the way to
the very long ones right away.”

“I think if rates came down a lot in the middle of the curve and
then we still felt like more had to be done we might move out at that
point,” he continued. “Of course we are buying across the whole curve,
but it’s just a matter of degree.”

Bullard was less inclined to be flexible about the type of
securities the Fed should purchase when asked whether the Fed might
resume buying MBS.

“I’m not too anxious to get back into mortgage backed,” he said. “I
think that the amount we purchased ended up causing some market
disfunction. I think we became such a huge part of the market that it
was hard to know where the private sector was in that area.”

“So I would rather not revisit that,” he said. “I think it makes a
lot of sense to stay in Treasuries if we can. Also you get away from
this issue of allocating credit to a particular sector of the economy.”

Besides, he noted, “Mortgage rates are already extremely low.”

Writing in July, Bullard warned that by continuing to signal that
it would keep the funds rate near zero “for an extended period” the FOMC
was running the risk of inadvertently steering the economy into
deflation. And he recommended more quantitative easing as an
alternative.

But the FOMC last Wednesday retained the “extended period” language
even while resuming quantitative easing. But Bullard was not displeased
by the latest policy statement.

“That’s okay,” he said. “I think what that’s doing is just
supplementing the near zero interest rate policy with something else,
which is Q.E., which is an active policy that can react to shocks, and
that this is helpful.”

“My story (in his July paper) was that if you’re just sitting at
zero for two years and you don’t do anything else, you don’t respond to
any shocks that come into the economy, well then I think you’re
susceptible to a disinflationary trend that might turn into deflation
and might just sit there,” he said. “That was my main concern. So … I
think it’s fine to leave the extended period language in there.

Bullard added, “we’re not going to move off the zero interest rate
policy now anytime soon anyway so I think it’s fine to just leave the
extended period in there.”

He went on to emphasize he is “not that keen on trying to do
something more with the extended period language.”

“Sometimes you hear people say ‘let’s make it super extended’…,”
he said. “I think it’s hard to make promises that far out in the
future.”

“A couple of years from now you don’t really know what the state of
the economy is really going to be,” he continued, “and if you try to
make a promise out that far there is so much uncertainty about what’s
going to happen that it doesn’t have that much bang for the buck … .
So I think we’ve probably done about as much as we can do in just
promising to stay at zero for an extended period.”

“Now in the theoretical literature, you’re supposed to be promising
to stay at zero for longer, but in those models there’s all this perfect
credibility, and everybody understands exactly what you’re doing, and
they completely incorporate that into their decisionmaking,” he went on.
“It doesn’t work that way in the real world.”

Asked whether the FOMC should remove the “extended period” language
when it completes QE2, Bullard replied, “That’s a decision the Committee
will have to make at that juncture.”

“It will matter how much progress we’ve made, but it will also
matter what the forecast looks like at that point,” he said. “If you
say, ‘Gosh, things are going pretty well; in fact we expect them to go
even better in the second half of 2011 and into 2012,’ then the risk of
keeping a big balance sheet might start to weigh on the Committee, and
even the extended period language could start to come back into play at
that point.”

“But we’ll have to see,” he said. “I think all that is lying in the
future to be decided.”

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