By Steven K. Beckner
DALLAS (MNI) – Although its interest rate reductions have not had
as much impact on the economy as hoped, the Federal Reserve can still
stimulate growth through the “exchange rate channel” and the “wealth
channel,” former Fed Vice Chairman Donald Kohn said Monday.
Kohn, speaking at the National Association for Business Economics
annual convention, said that allowing the dollar to depreciate would
give U.S. exports and in turn the U.S. economy a boost.
Kohn, who retired from the Fed last June, declined to speculate on
whether the Fed’s policymaking Federal Open Market Committee will launch
a third round of quantitative easing, but said it should consider
cutting the rate of interest it pays banks on excess reserves (the
IOER), even though he said it would have only a modest impact.
Kohn said the key to stronger recovery is greater confidence in
America’s political leaders. As things now stand, the high level of
uncertainty about fiscal, regulatory and other issues is restraining
hiring, investment and economic growth.
Citing various factors that are discouraging lending and making it
difficult for households and businesses to obtain credit, he said “low
interest rates are not nearly as expansionary as we thought.”
“Lower interest rates have not sparked as much housing demand or
refinancing as you would think,” he added.
However, this does not mean the “monetary transmission mechanism”
is broken, the Brookings Institution senior fellow said. Monetary
stimulus can also work through the “wealth channel,” i.e. by raising
stock prices and other asset values and thereby encouraging consumption,
and through the “exchange rate channel,” i.e. weakening the dollar to
make U.S. goods more competitive on world markets.
Although lower interest rates have not had the anticipated impact,
“I do think the wealth and exchange rate channels are still open and are
still effective,” Kohn said. “If the interest rate channel is a little
clogged … I don’t think the wealth and exchange rate channels are
particularly clogged.”
“If lower interest rates make foreign investments a little more
attractive than U.S. investments and the dollar falls that’s going to
help our export industries,” he said. “So I think easing monetary policy
has had positive effects.”
Asked about cutting the IOER from 25 basis points, Kohn said it
“should be under consideration” even though “it’s not going to cure
anything.”
“I don’t think banks are not lending because they can get 25 basis
points from the Fed,” he said.
Still an IOER cut should be considered by the FOMC, according to
Kohn, who said, “I don’t think it will make a big difference, but it
would help a little around the edges.”
At the same time, Kohn warned against anything that would have “an
unanchoring effect on inflation expectations.” He said that would be
“very adverse.”
Kohn said the larger problem with credit flows is the overhang of
distressed properties and the slow process of foreclosing on delinquent
home loans, which he said has kept low rates from leading to more
mortgage lending, home-buying and in turn home construction. He said
that process needs to be speeded up somehow.
He said the “headwinds” against economic recovery “turned out to be
stronger than I expected.” In particular, he said uncertainties about
housing are “making lenders very cautious.”
He noted that Fed surveys of bank lending practices have shown
“there has been no easing up in residential mortgage terms and
conditions (and) refinancings are very hard even for houses not
underwater.”
“We need to speed up the process of moving through distressed”
properties, Kohn said, adding that delinquent borrowers “who have no
chance of staying in their home” should not be allowed to “materially
slow the foreclosure process.”
Kohn said “credit conditions remain very tight” outside of the
housing sector as well. The normalization of bank lending is “taking a
bit longer than I anticipated.”
Uncertainty about new financial regulations are part of the
problem, he said but “we can’t allow that to impede the reform process.”
Reform is “absolutely necessary … to build a more stable
system,” he continued. “We need to weigh the costs and benefits (of
Dodd-Frank implementation) very, very carefully … . We need to move on
financial reform as rapidly as possible to remove uncertainty.”
Another headwind slowing the U.S. recovery, said Kohn, is the
European debt crisis, the extent of which Kohn said he did not
anticipate.
Still another headwind, he said, is the “huge fiscal policy
uncertainty.” He said the effects of a fiscal contraction to curb the
budget deficit could be offset by monetary policy, but he said the Fed
has only limited tools. He also said “unnecessary regulations” that
impose costs and uncertainties on businesses should be avoided.
In toto, “the U.S. economy is more vulnerable to downside
shocks,” he said, adding that a “multi-faceted approach” is needed.
“Most difficult is the issue of confidence,” he said. “What’s most
needed is added confidence … in the willingness of politicians to see
the problems and work through their differences to solutions.”
Asked about criticism of the Fed by Texas Governor Rick Perry and
other Republican presidential contenders, Kohn said “it is absolutely
appropriate” for politicians to discuss the pros and cons of Fed actions
“at any time.” However, he deplored “the lack of respect for (the Fed’s)
independence and the name-calling.”
Referencing Perry’s comment that further printing of money by the
Fed would be “almost treasonous” and that Fed Chairman Ben Bernanke
might be treated “ugly” in Texas, Kohn said, “I thought that was awful.”
And he deplored what he considered “veiled threats of physical
violence.”
Although Kohn seemed to countenance dollar depreciation, a panel of
52 NABE forecasters anticipated that “the foreign exchange value of the
dollar to remain relatively stable going forward.”
Wang Tongsan, director general of the Institute of Quantitative and
Technical Economics of the Chinese Academy of Social Sciences, told the
NABE conference, “We think the dollar is the strongest currency in the
world even though the U.S. has a lot of problems … . That’s why the
U.S. dollar is a major part of China’s foreign exchange reserves.”
“I think this kind of situation could be changed a little but
cannot fundamentally change in the future,” Wang added, after
acknowledging that the value of China’s dollar reserves could fall by “a
large amount” … “partially due to U.S. fiscal policy.”
Wang was responding to comments by Nicholas Lardy, senior fellow at
the Peterson Institute for International Economics, who charged that
China is continuing to keep its own currency, the yuan, “undervalued”
through massive foreign exchange intervention — buying dollars.
So far, Lardy said, China has “managed to keep its currency
undervalued and maintain price stability, which is something of a
miracle.”
But Lardy warned, “it won’t last in the long-term … . There is a
risk of substantially higher inflation” and other “major distortions” if
China continues to intervene to keep the yuan from appreciating as much
as it should.
“China is in a dollar trap,” Lardy said. “The currency is
undervalued … . They’re still building up foreign exchange reserves at
a rate of $100 billion per quarter … . And those reserves are “losing
value due to dollar deprecation . … Over time they are at risk of
losing purchasing power even in dollar terms. particularly if the U.S.
is not successsful in controlling its debt.”
At his inaugural press conference, new NABE President Kenneth Huang
ranked NABE forecasters’ main economic concerns as: 1. unemployment, 2.
the federal debt, 3, the European debt crisis, and 4. the government
regulatory burden. But he said that if they were to be surveyed now,
Europe might be higher in the list of concerns.
Although 50% of the 52 forecasters think it unlikely that Spain and
Italy will default, another 28% consider it very likely, while 22% give
even odds of a default.
Huang, chief economist of FedEx Corp, noted the high degree of
uncertainty about the outlook. Economists projections of GDP growth next
year range from zero to nearly 4%, he noted.
** Market News International **
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