By Steven K. Beckner
“While labor markets remain weak, they seem to have stabilized,” he
said, calling Friday’s March employment report “encouraging.”
Hoenig said consumer spending “has been growing at a solid pace,
and most forecasters put first quarter consumption growth at more than
3%.” He said consumer spending “will be a critical force strengthening
the recovery.” And he said “the manufacturing sector has followed the
consumer and also has been expanding at a strong pace.”
Hoenig said residential and non-residential construction “continues
to struggle,” but he said “looking ahead, spending should pick up
considerably in response to the extended tax credit and then rise at a
more moderate pace after the credit expires.” He said “the picture is
considerably bleaker for the non-residential sector.”
Hoenig said “inflation has drifted lower in recent months and is
following the pattern common during and after a recession….In the
absence of any current cost pressures from tight labor markets or other
input prices, inflation will likely remain low for the next year or
two.”
“With the economy gradually recovering from a severe recession,
monetary policy is by any measure highly accommodative,” Hoenig said,
adding that “by itself, the current state of the economy warrants an
accommodative monetary policy.”
“However, as the economy continues to improve, risks emerge around
the act of holding rates low for an extended period,” he added.
Hoenig explained that he dissented at the late January and
mid-March FOMC meetings “specifically because I believe the ‘extended
period’ language is no longer warranted and I am concerned about the
buildup of financial imbalances creating long-run risks.”
“There is no question that low interest rates stimulate the
interest-sensitive sectors of the economy and can, if held there too
long, distort the allocation of resources in the economy,” he
elaborated. “Artificially low interest rates tend to promote consumer
spending over saving and, over time, systematically affect investment
decisions and the relative cost and allocation of capital within the
economy.”
Hoenig cited research argued that “exceptionally low rates, while
perhaps not the single cause, played an important role in creating the
conditions leading to our recent crisis.”
He treated that as a cautionary tale for current policy.
“We now find ourselves with a Federal Reserve System balance sheet
that is more than twice its size of two years ago,” he said. “The
federal funds rate is near zero and the expectation, as signaled by the
FOMC, is that rates will remain so for an extended period. And the
market appears to interpret the extended period as at least six months.”
“Such actions, moreover, have the effect of encouraging investors
to place bets that rely on the continuance of exceptionally easy
monetary policy,” he continued. “I have no doubt that many on Wall
Street are looking at this as a rare opportunity.”
Hoenig said the Fed’s action were “taken with the well intended
purpose of assuring a strong economic recovery and to create an
environment of sustained job growth and strong business investment,” but
he said “the unintended negative consequences of such actions are real
and severe if the monetary authority goes too long in creating such
conditions.”
“Low rates, over time, systematically contribute to the buildup of
financial imbalances by leading banks and investors to search for
yield,” he said. “The search for yield involves investing in less-liquid
assets and using short-term sources of funds to invest in long-term
assets, which are necessarily riskier. Together, these forces lead banks
and investors to take on additional risk, increase leverage, and in time
bring in growing imbalances, perhaps a bubble and a financial collapse.”
Hoenig said he is not able to identify or prick asset bubbles, but
said he is “confident that holding rates down at artificially low levels
over extended periods encourages bubbles, because it encourages debt
over equity and consumption over savings. While we may not know where
the bubble will emerge, these conditions left unchanged will invite a
credit boom and, inevitably, a bust.”
Referring to the views of other Fed officials, Hoenig said he can
“appreciate the inclination for staying the course that financial
markets have come to expect: keeping the federal funds rate target near
zero and maintaining a commitment to very low rates for an extended
period of time. That view is motivated by concerns over an unemployment
rate of nearly 10% and persuaded by the fact that core inflation remains
below 2%.”
“Continuing with current policy may also reflect confidence that
the longer-term risks of financial imbalances are quite small and could
be mitigated as they emerge,” he continued. “The Federal Reserve could
correct imbalances through interest rate action or regulatory changes as
the imbalances become apparent later.”
“However, in times of uncertainty policymakers tend to reassure
themselves that an accommodative course of action can be reversed always
in a timely fashion,” he cautioned. “Inevitably, though, the policy bias
is to delay, to let accommodative conditions stand, and to reverse only
when the economy is beyond recovery and into an expansion.”
“The outcome too often is greater inflation, significant credit and
market imbalances, and an eventual financial crisis.”
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** Market News International **
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