February 13, 2013 / 4:14 AM / 5 years ago

Fed officials warn about doing too much, or too little

MADRID/STANFORD, California (Reuters) - The tug-of-war over U.S. monetary policy was on full display on Tuesday as one top Federal Reserve official warned against being too timid, two others focused on the risks of being too bold, and a fourth said the Fed’s policy was too vague.

Atlanta Fed President Dennis Lockhart, speaking in Madrid, predicted the U.S. economy would remain weak and cautioned that unemployment, at 7.9 percent last month, could become entrenched if left unaddressed.

“A sense of urgency is appropriate,” said Lockhart, a centrist who does not vote on Fed policy this year. “If policymakers are too patient, what started as cyclical problems can evolve into structural problems.”

The U.S. central bank is buying $85 billion (54.2 billion pounds) in Treasuries and mortgage-backed securities each month to boost the economy and has pledged to continue with asset purchases until the labour market outlook improves substantially.

In December, it went further into uncharted territory with a promise to keep interest rates near zero until unemployment falls to 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent, and to keep policy highly accommodative even after the recovery strengthens.

Lockhart’s view that such action is needed represents that of the majority of the Fed’s 19 policymakers, including Chairman Ben Bernanke.

But a handful of their more hawkish colleagues are less comfortable with the Fed’s aggressive policies.

Kansas City Fed President Esther George, a voter who dissented at a Fed policy meeting last month, said the Fed could disrupt markets if it actively sells large amounts of mortgage-backed securities when the time comes to tighten monetary policy.

Addressing an audience at University of Nebraska-Omaha, George also warned that investors could question the central bank’s commitment to its 2-percent inflation goal if inflation expectations begin to rise.

When the time finally comes, “actively selling a large amount of agency mortgage-backed securities ... could be potentially disruptive to markets and market functioning,” she said, adding: “These actions are untested.”

Jeffrey Lacker, the Richmond Fed’s hawkish president, reiterated his criticism of adding to monetary stimulus, saying the central bank’s large balance sheet will make it tougher to withdraw liquidity when the time comes.

“The more stimulus we provide, the greater the sensitivity to small errors in the timing and pace of withdrawal,” he told reporters after a speech in Lancaster, Pennsylvania.


A third vocal critic of the Fed’s easy policy, Philadelphia Fed President Charles Plosser, called for the central bank to be even more specific about its policy intentions.

The Fed’s policy-setting panel, the Federal Open Market Committee, “is silent on how policy will actually be conducted” once thresholds are reached, he said in a speech at the Stanford Institute for Economic Policy Research in California. “This vagueness runs counter to the theory that supports the use of this explicit form of forward guidance in the first place.” <ID:N9E8KD01K>

Plosser advocated adopting a simple policy rule that would allow markets to better predict how the Fed will react to a given set of economic conditions.

Bernanke has defended the Fed’s aggressive easy-money policies, arguing the economy needs to grow quicker to lower unemployment and withstand tighter fiscal policies and threats from abroad. He and others say the economy, especially interest rate-sensitive sectors like sales of homes and automobiles, has responded to monetary policy.

“While we’ve made progress, there’s still quite a ways to go before we’ll be satisfied,” Bernanke said in January.

Yet the slow overall recovery has cast some doubt on the U.S. central bank’s far-reaching strategy. Some Fed officials and congressional Republicans warn that the multitrillion-dollar quantitative easing efforts risk future inflation and could crimp the Fed’s ability to tighten policy when the time it right.

The U.S. economy likely expanded only slightly in the fourth quarter, despite an early government estimate that gross domestic product unexpectedly fell at a 0.1 percent rate. As it stands, overall growth was just 2.2 percent in 2012, below the 3-percent pace to which the United States is accustomed.

Hawks worry that the Fed’s thresholds express some tolerance for inflation to exceed its 2-percent goal.

That in turn “carries with it the risk that longer-term inflation expectations may flip above levels consistent with” the goal, George said, and “cause the market to question the Federal Reserve’s commitment to its inflation goal.”

Long-term inflation expectations usually predict actual inflation, George noted.

So far this year, U.S. inflation expectations have edged higher.

Lockhart said he expects the Fed will need to continue its asset buying into the second half of this year in order to keep pressure on long-term interest rates, and encourage investment and hiring.

Plosser said he expects unemployment to fall fast enough so that the Fed can begin to wean markets of its asset purchase program before the end of the year, and it could begin to contemplate a rate rise in the first half of next year.

“If my forecast is right and we are close to 7 percent unemployment rate near the end of this year, then I think we should at least to have begun backing off from our asset purchases,” Plosser said.

Additional reporting by Steven C. Johnson, Jonathan Spicer, Pedro da Costa; Editing by Andrea Ricci and Mohammad Zargham

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