By Steven K. Beckner
PHILADELPHIA (MNI) – Philadelphia Federal Reserve Bank President
Charles Plosser said Friday that the Fed and other central banks must be
willing to play their “lender of last resort” role should the European
debt crisis worsen, but said he would oppose further easing of U.S.
monetary policy unless European spillover effects on the U.S. economy
were to pose a deflationary threat.
Plosser, a voting member of the Fed’s policymaking Federal Open
Market Committee, said the European crisis poses “the biggest risk” to
the U.S. economy but stressed “we don’t know how it will play out.”
U.S. financial institutions are in better shape than European ones
and are not facing funding problems. Indeed, far from being hurt by the
European crisis, he said it’s conceivable that U.S. financial firms
could benefit from capital inflows into the United States.
Plosser, speaking to reporters during a break in a Philadelphia Fed
conference after the Labor Department released an upbeat November
employment report, said he was “encouraged” by the jobs data. He said
the department had been “underestimating” the strength of labor markets
in recent months.
Plosser, who is serving on a task force on FOMC communication
headed by Fed Vice Chairman Janet Yellen, said he favors a more clear
statement of the FOMC’s objectives and the conditions under which it
would raise the federal funds rate. But he stressed he does not see that
as an easing tool.
The Labor Department reported Friday morning that the unemployment
rate dropped 0.4 to 8.6% in November and that non-farm payrolls rose
120,000, coupled with a 72,000 upward revision to prior months.
Asked by MNI about those better-than-expected numbers and about the
countervailing clouds from Europe, Plosser said the jobs data confirms
his view that the labor market situation is “not great but clearly not
as dire or as pessimistic as feared.”
He predicted the economy will stay “on this moderate slog out of
recession,” though not at high growth rates. He noted that employment
reports since August have shown a “pattern of consistent upward
revision.”
“I’m somewhat encouraged by those numbers,” he added.
As for Europe, he said the Fed must be “cognizant of the fact that
this is a tail risk … .” He said the European crisis adds “just
another layer of uncertainty” that “holds people back to wait and see
what happens.”
But Plosser suggested the European threat should not be
overweighted, as he implied the FOMC has done in recent months.
“There is no evidence in the U.S. that our financial institutions
are facing funding problems,” he said. “The (currency) swap lines are
not particularly being used right now … . Nothing is falling apart
right now.”
But, he said, “We really don’t know how will play out,” adding,
“it’s a scary scenario” because “an implosion in Europe would freeze
funding markets for everybody.”
And so Plosser said “it’s important and appropriate that central
banks act as lender of last resort.”
“But it may not play out that (negative) way,” he went on. “It
may play out in a different way.”
It could be “there will be flight to quality” and “rather than
U.S. banks being short of capital, they could be flooded with
liquidity.”
“That would be a different type of problem we’d have to deal with,”
he said, adding, “I don’t know which of those scenarios is most
likely.”
Plosser observed that credit markets are “tiering” and looking at
“who’s at most risk here … . They’re not treating everybody the
same.”
Even so, he said the Fed must “be prepared to pull out our tool
kit” to provide liquidity if needed.
But when asked whether the Fed should be prepared to ease policy
further, Plosser was more reticent.
“It depends on how you think this plays out in terms of inflation,
inflation expectations and unemployment,” he said.
“Right now I don’t see any risk of deflation,” he said, but “if
we were to return to a situation where deflation was a serious risk
then I would want to defend our objective of price stability on the
downside as well as on the upside.”
Plosser added, however, that “I don’t see that as a very likely
scenario.”
Reiterating what he has said before, Plosser said the Fed should
clarify its intentions by having an inflation objective and by
announcing the conditions that would guide changes in the federal funds
rate, rather than using a calendar date as the FOMC has done since
August in saying it expects the federal funds rate to stay near zero
“through at least mid-2013.”
He said “a lot of people are now coming to believe” that “a much
better way” would be for the FOMC to clearly state its objectives and
its “reaction function.”
Stating the economic conditions under which the FOMC would begin
withdrawing accommodation “may provide more stimulus … if the
committee signals that rates will be lower longer.” But he said
“that’s not the way I look at it.” Rather, he said, he just wants to
see “better communication.”
Plosser said the FOMC needs to define monetary policy on the basis
of objectives like inflation, inflation expectations and resource
utilization … . Then we need to talk about our policy at every
step … (and) be able to explain why we made a decision in terms of
our evaluation of those key variables.”
The FOMC “ought not to just be able to pull things in a random
manner to make policy on a whimsical basis,” he added.
Using communication as an easing tool is “the wrong way to think
about our policy strategy … . It’s a strategy, not a means to an
outcome,” he said.
Asked whether the FOMC should have a numerical unemployment
objective or trigger, as well as an inflation objective, as proposed by
Chicago Fed President Charles Evans, Plosser called that the “$64
trillion question.”
“Many people (on the FOMC), myself included, would be uncomfortable
having an explicit unemployment goal,” he said, because “unemployment is
affected by way too many things.”
He observed that the FOMC does have, as part of its quarterly,
three-year Summary of Economic Projections, a long-run forecast for
unemployment, which he said is subject to change.
On Wednesday morning the Fed and other major central banks
announced a 50 basis point reduction in the rate at which banks can
borrow from their central banks’ dollar swap lines.
Asked whether collateral requirements should also be eased, Plosser
said, “that will be the ECB’s problem … . It depends on the nature of
the problem.”
He observed that so far use of the swap lines has been “pretty
trivial.”
** Market News International **
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