–Fed Should Not Let Markets Dictate Policy

By Steven K. Beckner

PHILADELPHIA (MNI) – Philadelphia Federal Reserve Bank President
Charles Plosser said Wednesday that additional quantitative easing would
probably do little to lower unemployment, and he said would tend to
increase long-term inflation risks and further weaken the U.S. dollar.

Plosser, talking to reporters following a speech to the Union
League Club, said that expanding the Fed’s balance sheet through
so-called “QE2″ would make the Fed’s eventual “task” of exiting from its
easy money policy much tougher.

Plosser, who will be a voting member of the Fed’s policymaking
Federal Open Market Committee next year, also said it would be
“dangerous” for the FOMC to adopt QE2 just to fulfill market
expectations. He said it would be better for the FOMC to “disappoint the
markets” and focus on its long-term objectives.

Plosser said he could conceivably change his views if his forecast
were to change, but said that now he sees little risk of deflation. On
the contrary, he predicted inflation will edge up and run in the 1.5% to
2.09% range next year. And he said he doesn’t perceive high unemployment
as being “amenable” to monetary measures.

“There are a lot of reasons to be cautious about how we conduct
policy,” he said. “As the Chairman has said repeatedly, we need to
evaluate the costs and benefits … . That’s what a lot of the discussion
is about, trying to do that.”

“Since I’m less concerned about deflation risks than some of my
colleagues … I am less inclined to want to follow that (QE2) policy”
to “raise inflation and inflation expectations.”

“The unemployment problem is a terrible problem,” he said, “but
it’s less obvious to me that it’s amenable to monetary policy solutions
at this point.”

“We’ve done a lot,” he said, adding that he does not think QE2
would be “effective” in bringing down jobs. And “if it’s ineffective
that’s bad for the credibility of the Fed.”

Plus, he said, if the Fed were to add another $1 trillion to the $1
trillion in excess reserves already in the banking system, the Fed’s
eventual exit problem “is doubled.”

Earlier, in response to a question from the audience, Plosser said
that pumping more reserves into the banking system through bond
purchases amounts to providing “kindling for money creation and
inflation ultimately.”

Right now excess reserves are “just sitting there,” but he said
that when banks begin lending the Fed will have to be ready to withdraw
reserves quickly to avoid an inflationary upsurge. Greatly increasing
those reserves through QE2 will make the task that much harder, he said.

Asked by MNI to what extent the FOMC’s decision will be influenced
by heavy market expectations of QE2, Plosser said the FOMC should not
let markets “dictate” policy.

“We need to keep our focus as policymakers on the intermediate to
longer term” and “make the right decision,” he said, adding that if the
Committee’s decision “disappoints markets, that may be short-run painful,
but it is the right long-term decision.”

“I would prefer not to be in a position where monetary policymakers
feel trapped by market expectations,” he said, adding that it is “very
dangerous if we put ourselves in a position where that comes true.”

Asked by an audience member why the U.S. dollar is “in free fall,”
Plosser said he thinks the dollar’s slide is “primarily” because people
are “worried about inflation.”

He said this fear was likely exacerbated by the FOMC’s own
indication following its Sept. 21 meeting that “we would like a little
more inflation.”

“Regardless of whether you think that’s good or bad … if
inflation in the U.S. picks up that will send the dollar down,” he said.

Plosser said the dollar is also weaker partially because ” U.S.
growth over the course of summer kind of stumbled … . The recovery we
thought was entrenched wasn’t so well-entrenched.”

“The weaker economy also leads to a weaker dollar,” he said.

MNI asked Plosser whether the FOMC will or should take into
consideration the potential impact of a QE2 authorization on currency
markets.

Plosser said that he personally thinks of the dollar exchange rate
as “an input” into monetary policymaking, rather than “an output.”

“The way I think about exchange rates … I try to ask myself what
are exchange rate movements trying to tell me,” he said. “If I have
sustained movements in the dollar what does that tell me about our
economy vis a vis our trading partners.”

He said exchange rate movements may mean “people might expect
inflation to rise in the U.S.” and said he is inclined to ask “is it
telling me something about inflation.?

Plosser sounded dubious about proposals for an explicit price level
target, saying, “it’s a little difficult to move to price level target
when you don’t even have an inflation target.”

He added that “the justification (for QE2) also comes from models
in which Q.E. plays no role … . So I think we’re in an environment
where lot of our theories … and the models we work with don’t fit very
well.”

Plosser said he continues to be an advocate of inflation targeting.
He said the Fed needs to commit to a specific inflation rate.

Asked by an audience member whether Q.E. amounts to “monetizing the
debt,” Plosser replied that when the Fed purchases government securities
in the market and removes them from circulation “as a practical,
technical matter, yes that is monetizing government debt.”

However, he emphasized, that the Fed has been buying Treasury
securities “for monetary, not fiscal purposes.”

** Market News International **

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