–Fed’s Rosengren: Even If Growth Better Than Expected, Keep Accomm

By Steven K. Beckner

NEW YORK (MNI) – Boston Federal Reserve Bank President Eric
Rosengren Tuesday said the Fed may need to make monetary policy even
more stimulative if economic growth proves disappointing and if
unemployment remains “unacceptably high.”

In remarks prepared for delivery to the the National Institute of
Economic and Social Research in London, Rosengren, who is not a voting
member of the Fed’s policymaking Federal Open Market Committee this
year, suggested price stability should be no obstacle to further Fed
easing as he projected that inflation will subside to below 2% next year
following a temporary, energy-induced rise.

At the very least, he said, the Fed should refrain from removing
monetary accommodation until it is closer to achieving its statutory
“dual mandate” of maximum employment and price stability.

Although there have been improvements in economic and financial
conditions, Rosengren made clear he thinks they are inadequate, possibly
transitory and subject to downside risks.

Although financial market strains related to the European debt
crisis have moderated, Rosengren said he remains concerned about longer
term risks — particularly with regard to potential dollar funding
shortages and European banks’ heavy reliance on U.S. money market funds.

He did not specify what kind or how much additional monetary
stimulus the Fed should be prepared to add, but one can only suppose he
was referring to a potential third round of quantitative easing — a
“QE3.”

“If real GDP does not grow more rapidly and unemployment remains at
its current unacceptably high level, monetary policy may need to be more
accommodative,” Rosengren said.

“The U.S. unemployment rate remains well above a level that could
be considered full employment, while we are likely to undershoot our
inflation targets,” he continued. “Together these factors provide room
for flexibility in the response of monetary policy as we receive
additional information on current economic conditions.”

Later in his speech, Rosengren had a somewhat different formulation
on prospective easing.

“In the United States, accommodative monetary policy has been
essential to improving financial conditions, but growth remains
disappointingly slow to date, and significant downside risks remain,” he
observed. “Should growth slow down more than is expected, more policy
accommodation could be advisable.”

“Even if growth should improve more than expected in the U.S., the
country will likely remain far from what anyone would consider full
employment — so in my view policy accommodation should only be removed
once it is clear that the Fed’s dual mandate can be achieved within a
reasonable period of time,” he added.

Not unlike Fed Chairman Ben Bernanke Monday morning, Rosengren
viewed recent more positive employment data skeptically.

He called labor market improvements “painfully slow” and suggested
that even they may not persist.

While the bigger payroll gains and decline in unemployment may show
the recovery “gaining traction,” he suggested an alternative
explanation: “focusing only on the weak spending data might lead one to
conclude that the improvements in labor markets and financial conditions
are going to prove temporary, because the recent improvements are
probably unsustainable if the U.S. economy continues to grow at only a
2% rate.”

Rosengren said “it may take several quarters before we know which
of these two perspectives is actually better reflective of the U.S.
economy today.”

And while financial market conditions are “clearly improving”
because of the “oderation or removal of some significant, imminent,
downside ‘tail’ risks,” he said his “enthusiasm is tempered by the
challenges still facing Europe.” He also cited risks from oil prices and
the budget deficit.

Rosengren forecast 2.5% real GDP growth, but said that is “only
fast enough to make modest headway at reducing the unemployment in our
labor market.”

Again echoing Bernanke, he said that “given the very modest
recovery to date, it is surprising that the unemployment rate … has
shown as much improvement as it has.”

The official unemployment rate has fallen from 9.1% last summer to
8.3% as of February, but Bernanke suggested this is “out of sync” with
GDP growth that fell shy of potential last year. Rosengren was making a
similar point.

What’s more, he said, “while the unemployment rate has declined,
there has not been much improvement in the important ratio of employment
to population … . So part of the decline in the unemployment rate is
resulting from workers leaving the labor force.”

As a result, “the U.S. remains well below the employment levels
that would be viewed as consistent with the maximum sustainable
employment aspect of the Federal Reserve’s so-called dual mandate.”

Meanwhile, on the price stability side of the dual mandate,
Rosengren saw no need to worry.

While the price index for personal consumption expenditures (PCE),
the Fed’s favorite inflation gauge, is above the Fed’s 2% target and
while it will “likely … rise further” due to the spike in oil and
gasoline prices, Rosengren said “this increase is likely to be
temporary.”

“For 2013 my own forecast is for both total PCE and core PCE
inflation to be below 2%, although this forecast assumes that Middle
East tensions do not result in another sharp spike in oil prices,” he
said.

Rosengren made light of concerns in some quarters that the Fed’s
expansion of its balance sheet to roughly $3 trillion through two rounds
of quantitative easing could become inflationary.

He noted that commercial real estate lending is still declining and
that commercial and industrial lending, though up, “has yet to return to
its level at the beginning of the recession.”

“What this means it that by and large, the expansion of the Fed’s
balance sheet has not turned into a significant increase in the supply
of money, because banks have not been lending out their holdings of
excess reserves,” he said. “So the expansion of reserves that occurred
in 2008 as the Fed expanded its balance sheet has not been inflationary,
given the subdued bank lending environment.”

Although financial markets have strengthened since the crisis,
Rosengren said “safeguarding against runs on financial entities like
money market funds — entities that do not have a large, stable, core
deposit base and do not have ordinary access to the central bank’s
‘lender of last resort’ function — was and is important, unfinished
work if we are to have a more stable financial system.”

Heavy withdrawls of money from money market funds, which had
invested heavily in European debt instruments, led to severe credit
strains in Europe and to increases in key rate spreads in recent months,
and though those strains have subsided, Rosengren warned “money market
funds will continue to be a potentially unstable source of U.S. dollar
funding.”

“In light of the incentives facing money market funds, financial
institutions that rely heavily on them for funding put themselves in a
position where a short-term change in perceived risk can create
significant funding problems,” he said.

The European Central Bank, working closely with the Fed, acted to
alleviate liquidity strains in recent months, but Rosengren said “we
need to get to the point of having a more resilient financial
infrastructure that does not require central bank interventions during
times of stress.”

He urged that, in future, bank stress tests “assess how well
risk-sensitive sources of short-term funding will hold up in an
environment of heightened risk.”

** MNI **

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