–Rapid Re-entry of Excess Reserves Back Into Econ Would be A Challenge

By Brai Odion-Esene

ROCHESTER, NY (MNI) – The decision whether or not to continue
buying long-term U.S. government securities will be contingent on the
state of the economy and how it evolves, Philadelphia Federal Reserve
Bank President Charles Plosser said Thursday.

Given that he will be a voter on the Federal Open Market Committee
in 2011, Plosser said in subsequent meetings he will be looking at state
of the economy, the state of inflation, and the outlook for
unemployment, “to make an assessment, at the appropriate time, if this
is still the right policy.”

“I don’t know how the economy is going to evolve … . We’ll have
to wait and see,” he told reporters following a speech at an economic
forum in Rochester.

Elaborating on what he would like to see before pushing for the
$600 billion program to be adjusted or ended, Plosser said “if growth
continues to pick up and expand, if inflation begins to pick up — stops
falling — begins to sort of firm up,” those would be reasons to start
thinking if “it’s the right decision.”

Plosser repeated that he remains skeptical of arguments made by
some that the benefits of the Fed’s large scale asset purchase program
outweighs the costs, and that he is still not sure that it will have the
desired impact on the economy.

Plosser, in keeping with his hawk credentials, also reiterated his
belief that price stability should have “primacy” in the Federal
Reserve’s execution of its mandates.

“Providing a stable price environment is the best way for the Fed
to … support economic growth and stability,” he argued. “The Fed is
the only institution in government that can achieve price stability.

On the future threat posed by the massive amount of excess bank
reserves being held at the Fed, the Philadelphia Fed president said
there is uncertainty as to when and how quickly those reserves will turn
into loans and make their way back into the economy.

When the reserves start flowing, Plosser warned, ” We are going to
have a challenge.

“If it comes about in a rapid way, we may face a challenge — can
we raise rates fast enough to prevent all that stuff from flowing out?”
he said. “We don’t know for sure.”

However, if the flow of excess reserves back into the money supply
is very gradual, “then it is probably very manageable,” he said.

This is why it is dangerous for the Fed to expand its balance
sheet, Plosser said, as the more its grows, the more it has to be able
to “corral” the excess reserves and keep them from being converted to
loans.

It could also lead to distortions in asset prices, he added.

Many have defended the Fed’s decision to implement an additional
asset purchase program by citing the stalemate in Congress, which forced
the central bank to step and fill the void to aid the economy.

“I think that’s the wrong reason to take action,” Plosser
countered. Targeted government programs, aimed at improving the
efficiencies in the labor market, are what is needed, he said.

“Those might be more effective means of improving the pace of
recovery in the labor market,” he went to say, as opposed to a “blunt
instrument” like monetary policy.

As for renewed fears surrounding the sovereign debt situation in
Europe, Plosser said, “Europe is a risk out there for us,” but at the
same time he does not believe, right now, that it will impact the
momentum of the economic recovery in the U.S.

“So that would be one of the risks to my forecasts,” he said.

Asked to comment on the revised plan unveiled by the co-chairs of
the Fiscal Commission Wednesday, all Plosser would say is that the panel
is making to effort to deal with “an important fiscal problem,” and that
Congress will have to come to grips with the “big challenge” that is the
deficit at some point.

** Market News International **

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