–What Happens After June 30 To Depend A Lot On Inflation
AVENTURA, Fla. (MNI) – Should inflation approach 2% during the
course of 2011 as Chicago Federal Reserve President Charles Plosser
expects, he wouldn’t be “surprised” to see the central bank act before
the end of the year, he said Thursday.
What happens after June 30, when the Federal Reserve is scheduled
to end its second round of quantitative easing, will depend on how the
economy evolves, and particularly “will depend a lot on inflation,” as
well as inflation expectations, Plosser told reporters following a
speech at the New Jersey Bankers Association’s 107th conference.
He also indicated that once the Fed starts its exit strategy, there
can be periods of hold and periods of action.
“People shouldn’t assume that even if we move away from the zero
bound or stop reinvesting or something,” he said, that the Fed would act
“on a continuous basis.”
The Fed could be on hold during some meetings and act at others, he
said, adding that big moves would not necessarily happen at the two-day
meetings.
That said, it is logical that at two-day meetings, it would be
easier to have more significant changes in language, he said.
In any case, “It’s going to be a long time before monetary policy
will get to any point that you might think of as being tight,” Plosser
said.
The key is to come up with a plan, he continued. In fact, Congress
should also come up with a plan to address its “serious” fiscal
challenges, he said.
However, Plosser doesn’t expect the U.S. to default on its debt and
investors to shy away from dollar-denominated assets.
The credibility of the U.S. Congress “is being deeply undermined,”
Plosser said, which is “troublesome.”
“But having said that, I don’t think the U.S. is going to default
on its debt,” he continued, noting the U.S. Treasury market is still
the deepest in the world, which is unlikely to change in the near term.
“It’s not in their interest to sort of go out and dump a lot of
U.S. government securities,” Plosser said of investors. They would take
“huge capital losses.”
So he doesn’t “worry too much” about this issue, expecting U.S.
government securities to remain “in demand.”
His concern at the moment is about the Fed having a plan to end the
zero interest rate policy.
In that regard, “Monetary policy will continue to be state
dependent,” he said.
There are different ways as to how to put a plan together and “We
are actively discussing exactly how that might work,” Plosser said.
He stressed that, “We don’t fully understand as well as we’d like
the implications particularly of balance sheet management.”
When it comes to asset sales, he said the concern is not so much
about disrupting the market but about the portfolio balance effect.
“As the economy improves, the demand for risk and duration will
grow,” Plosser expects, and it’s easier to sell in such a market. How to
judge the pace is the issue.
“There is a lot of uncertainty about what the right strategy could
be,” he said, but the Fed should articulate the objective: shrinking the
balance sheet to where the fed funds rate is the policy instrument, with
the balance sheet returning mostly to Treasuries, especially short-term
Treasuries.
Where there is nearly no uncertainty is that QE2 will end as
scheduled and that there won’t be an additional round of quantitative
easing, he suggested.
Regarding QE2, “I don’t think there is any point in ending it now,”
as nothing extraordinary has happened. “Besides, it’s mostly done
anyway.”
“I think it’s a built-in in the market,” he said, expecting no
disruptive effect.
In addition, “We made pretty clear there is no QE3 on the table,”
he also said, adding he doesn’t see “any need for that.”
That said, in the end, “It all depends on how the economy evolves,”
Plosser said.
He warned, however, that “The economy doesn’t have to be really
robust to get inflation.”
“You don’t wait until inflation rate becomes over 2% to begin react
to it, because if you do, you know you will overshoot,” he said.
“We can’t wait ’til it’s there.”
As he expects inflation to gradually drift towards 2% during the
course of this year, “if those underlying or medium-term projections for
inflation continue to approach 2%,” he said, “we need to start taking
our foot off the accelerator.”
If his forecast materializes, he said, “I wouldn’t be surprised if
we wouldn’t have to take some action before the end of the year of some
kind,” although it will depend on other economic developments as well.
Asked whether getting away from the zero bound could derail the
recovery of the housing market, he said, “I don’t think that’s the
problem with the housing market,” where the issue is more about supply
and vacancies.
Yet that’s another reason for uncertainties about how the Fed will
rebalance its portfolio and getting out of mortgage-based securities.
“We may have to feel our way along a little bit,” Plosser said.
In implementing the exit strategy, Plosser said what comes first
doesn’t really matter,” referring to the tools that would be used first.
“The goal is to shrink the balance sheet, its composition, and to
gradually raise interest rates.”
All the combinations have “similar” impacts, he said.
Asked whether the current Fed policy was fueling asset bubbles,
Plosser said, “I don’t think so yet,” although the Fed does need to be
concerned about creating distortions in some markets by keeping interest
rates so low for so long.
Such policy is distorting price signals and encouraging leverage.
So “I’d rather get us away from the zero bound,” he said.
Asked about the rise in commodity prices, Plosser said when it
comes to oil prices, the increase is partly due to rising global demand,
and partly die to developments in the Middle Eats and North Africa.
“A lot of it is uncertainty and a lot of it is just growth and
demand,” he commented.
“It’s very hard” to dissociate all those effects,” he said, but in
the end, in the long run, it’s monetary policy that causes inflation,
not commodity prices.
** Market News International **
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