By Steven K. Beckner
(MNI) – Richmond Federal Reserve Bank President Jeffrey Lacker
raised strenuous objections to both the Fed’s asset purchases and its
communications strategy Tuesday, while suggesting that the central
bank’s credit policy is “adrift.”
What’s more, the Fed is not abiding by its own accord with the U.S.
Treasury, inked in March 2009, designed to limit “credit allocation” by
the Fed and insulate it from involvement in “fiscal” matters.
Lacker, a voting member of the Fed’s policymaking Federal Open
Market Committee who has dissented at every FOMC meeting this year, did
not speak about the economic outlook or about future monetary policy
choices. But he left little doubt that he will continue to oppose
large-scale asset purchases, particularly buying of mortgage-backed
securities.
He questioned the effectiveness of this so-called “quantitative
easing,” as well as the propriety of trying to lower interest rates in
one sector, housing, at the expense of others, such as small business,
in remarks prepared for delivery to a Shadow Open Market Committee
conference in New York City.
Lacker was equally vociferous in challenging the FOMC’s effort to
stimulate the economy by trying to convince markets and the public that
it will keep the federal funds rate near zero for an extended time
period.
Lacker will have a final chance to dissent when the FOMC reconvenes
Dec. 11-12.
The Fed’s “Maturity Extension Program” or “Operation Twist,” under
which it has been buying $45 billion per month in long-term Treasury
securities, is set to expire at year’s end. Some of his colleagues have
advocated fully replacing those purchases, which have been financed by
the sale of an equal amount of short-term Treasuries, by outright
purchases financed by the creation of new bank reserves.
In effect this would mean an expansion of the third round of
quantitative easing (QE3), which now takes the form of $40 billion per
month of MBS purchases, to $85 billion per month.
Lacker supported the Treasury purchase component of QE1, but
explained that he has since opposed Fed asset purchases because they
have “increasingly focused on altering the composition of the Fed’s
asset holdings in order to affect the net public supply of assets with
particular characteristics and thereby affect their relative prices.”
“There is ample room for skepticism about the effect of the Fed’s
asset purchases on asset returns,” he said. “The empirical
evidence on the effects of Fed asset purchases, which is based on yield
movements around the announcements of asset purchases, is ambiguous,
given the difficulty of parsing policy signals from pure supply
effects.”
“When the Fed expands reserves by buying private assets, it extends
public sector credit to private borrowers,” he said. “To the extent that
purchases of private claims have any effect, they do so by distorting
the relative cost of credit among different borrowers. Such differential
effects are unlikely to be beneficial, on net, unless borrowers in the
favored sector would otherwise face artificially high rates.”
Lacker said “it’s difficult to make this case for agency MBS, a
sector that historically has benefited from heavy subsidies, which
arguably contributed to dangerously high homeowner leverage. So I do not
see the rationale for reducing the interest rates paid by conforming
home mortgage borrowers relative to those paid by, say, small-business
borrowers.”
Besides, Lacker said purchasing agency MBS “encourages the
continuation of a housing finance model based heavily on
government-sponsored enterprises, at a time when the housing sector
would be better served by a new model that relies less on government
credit subsidies.”
On March 23, 2009, as the Fed was engaged in an array of
unconventional and unprecedented efforts to counteract the financial
crisis, it signed a Joint Statement with the Treasury which, among other
things, said “decisions to influence the allocation of credit are the
province of the fiscal authorities.”
Fed MBS purchases violate that accord, according to Lacker, who
warned, “the apparent contradiction between the March 2009 Treasury-Fed
statement and the FOMC’s recent interventions to steer credit to the
housing market also may be contributing to the perception that Federal
Reserve credit policy is adrift.”
Lacker likened selective Fed asset purchase policies to the
“constructive ambiguity” about its willingness to rescue financial firms
practiced by the Fed leading up to the bail-out of Bear-Stearns in March
2008, which fuelled expectations of subsequent bail-outs that weren’t
fulfilled in the case of Lehman Brothers six months later.
“Constructive ambiguity became increasingly hopeless in the face of
accumulating instances of intervention, and the toxicity of credit
policy opacity is now quite clear,” he said. “Financial stability is
likely to remain elusive without constraints on ad hoc rescues of firms
facing financial stress.”
By using its capacity to expand its balance sheet to “direct the
flow of credit toward particular market segments,” the Fed is
“circumventing the constitutional checks and balances that would
otherwise apply to such fiscal initiatives” and risking “entanglement in
partisan politics,” Lacker warned.
Lacker noted that the Dodd-Frank Act limited Fed lending to
non-depository institutions in “unusual and exigent circumstances” under
its Section 13(3) authority. But he said those restrictions are too
“modest.”
“If the Federal Reserve cannot limit credit policy of its own
accord, legislation may be the best option,” he said. “And the restraint
of credit policy would not be complete unless limits on reserve bank
lending are complemented by limits on the Fed’s ability to buy private
sector assets.”
Lacker also questioned the Fed’s use of “forward guidance” on the
path of the funds rate, most recently its twin assertions that the funds
rate is likely to be kept near zero “until at least mid-2015″ and that
monetary policy will stay “highly accommodative … for a considerable
time after the economic recovery strengthens.”
The FOMC’s aim is to stimulate the economy by “assuring the public
that it will keep its interest rate target at the zero bound longer than
it would if it were following its normal pattern of behavior,” but
Lacker said “it’s not clear whether this mechanism can work … without
raising expected inflation over some horizon.”
He said “adopting such a strategy without compromising longer-term
credibility may be feasible in model environments, where absolute
credibility can easily be assumed.”
But in practice “a central bank’s credibility is often contingent
and incomplete,” and “the Fed’s credibility is not so unassailable that
inflation expectations can be dialed up for a time and then easily
dialed back to price stability.”
“At the very least, the precedent set by an opportunistic attempt
to raise inflation temporarily is likely to cloud our credibility for
decades to come,” he warned.
Lacker indicated he wouldn’t oppose laying out a set of economic
conditions for raising the funds rate and/or shrinking the Fed’s balance
sheet — as opposed to using a moveable calendar date. But he cautioned
against “spurious precision,” a phrase he used in a recent MNI
interview.
In an obvious reference to proposals by Chicago Fed President
Charles Evans and others, he noted, “Some of my colleagues have
suggested that the Committee provide specific numerical thresholds to
help characterize future policy. For example, they suggest that the
Committee state that interest rates will be exceptionally low at least
until the unemployment rate falls below some specific number, as long as
inflation is projected to be close to the Committee’s 2% objective, and
inflation expectations remain stable.”
But Lacker said such an approach would place too much weight on a
single indicator of labor market conditions, unemployment, which “can
easily lead you astray.”
“Crisp numerical thresholds may work well in the classroom models
used to illustrate policy principles, but one or two economic statistics
do not always capture the rich array of policy-relevant information
about the state of the economy,” he said.
Nor was Lacker convinced that the economy would be protected from
rising inflation and inflation expectations by numerical thresholds.
So-called “safety valves” in numerical threshold schemes which
provide that the funds rate will be kept near zero so long as inflation stays
below a certain rate (3% in Evans’ case) are “an inadequate defense
because it essentially requires that we lose a measure of credibility
before it can be invoked,” he said.
“Our policy should strive to maintain the stability of inflation
expectations,” Lacker went on. “At times, this requires a preemptive
tightening of monetary policy, before inflation expectations have
deteriorated or inflation has surged.”
** MNI **
–email: sbeckner@mni-news.com
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