–QE Lets Fed Avoid Liquidity Trap
By Steven K. Beckner
SEATTLE (MNI) – San Francisco Federal Reserve Bank President John
Williams said Wednesday that the Fed can push long-term interest rates
even lower to boost the economy and indicated he favors doing so.
Williams, talking to reporters following a luncheon address to the
Seattle Rotary Club, said that another round of quantitative easing
would have a larger impact on rates than some of the other policy
options which Fed Chairman Ben Bernanke has mentioned.
He said past large-scale asset purchases, better known as “QE1″ and
“QE2″ proved effective in lowering rates and preventing the economy from
being even weaker than it otherwise would have been. He said those
tactics enable the Fed to avoid a classic “liquidity trap,” in which the
zero bound on short-term rates prevents a central bank from providing
more stimulus.
But Williams stopped short of saying a “QE3″ is what he favors at
this time, saying that the Fed’s policymaking Federal Open Market
Committee will have to decide the “magnitude” of the “dose” of monetary
stimulus that is in order when it meets Sept. 20-21.
Williams, who will be a voting member of the FOMC in 2012, left no
doubt whatsoever, though, that his will be a voice for further easing of
some sort and size.
In terms of the Fed’s statutory “dual mandate” to pursue both price
stability and maximum employment, he said that unemployment is clearly
the bigger problem at this stage. He said higher inflation does not pose
a threat.
At the same time, though, Williams indicated, that he would not
favor trying to reduce unemployment by deliberately allowing inflation
to run above target for awhile, as Harvard economist Kenneth Rogoff has
advocated, with the apparent approval of Chicago Fed President Charles
Evans.
Although he observed that the yield on the 10-year Treasury note
fell below 2% again Wednesday, Williams said, “there is still room for
lowering interest rates … . There is still considerable room where
monetary policy could improve economic conditions.”
Asked whether he favors more monetary stimulus now, Williams
replied that “we’re going to be a very long way from our goals for a
long time.” And so, he added, “if anything more monetary accommodation
seems appropriate than not.”
Williams was unwilling to say what form that accommodation should
take, saying that he is looking forward to the Sept. 20-21 analysis,
forecasting and discussion before making up his mind.
Bernanke, in his mid-July Monetary Policy Report to Congress,
outlined several options, including one already taken by the FOMC at its
Aug. 9 meeting, when it announced its conditional intention to keep the
federal funds rat near zero through at least mid-2013. The others were
another round of Q.E., lengthening the average duration of the Fed’s
securities portfolio to put downward pressure on long-term rates and
cutting the interest rate which the Fed pays on excess reserves (the
IOER) from the prevailing 25 basis points.
Williams said these various options “are substitutes for each other
in some ways.” But he said “there are differences in magnitude.”
The FOMC’s “choices will depend on the desired magnitude or dose of
stimulus,” he said.
“Some of these options are relatively limited” in their impact,
Williams went on, noting that the IOER can only be cut from 25 basis
points to zero. “That’s pretty much it … . You’re limited in how much
you can get out of that.”
While “holding the balance sheet at its current size, extending
duration would lower long-term interest rates,” he continued, “but again
you’re only talking about a certain amount of extra effect on interest
rates.”
“Obviously further expansion of the balance sheet would have
effects depending on how big it was,” Williams said, adding that
“there’s a limit to how far you can go” but “the potential magnitude is
greater.”
Asked whether he was concerned that the Fed might lose credibility
if it did push yields down further without any noticeable positive
impact on the economy or employment, Williams indicated he was not.
“These policies have worked and will work in the future,” he said.
“I also think credibility is something you lose if you don’t do the
right thing … . So the way we earn our credibility and hold our
credibility is by making the best decision with the analysis we
have … . You gain credibility or lose it through your actions.”
Earlier, 2011 FOMC voter Evans called for “strong action now” by
the Fed to spurt growth and suggested that he agrees with Rogoff’s call
for allowing higher inflation for some period of time. He said his
easing proposals “may result in inflation running at rates that would
make us uncomfortable during normal times. but we should not be afraid
of such temporarily higher inflation results today.”
But Williams took a different view. He said “the fact that
inflation is above 2%” now is “not something I’m deeply disturbed
about.” But he said the Fed should not deliberately aim to keep
inflation above 2%.
“An important lesson of the ’70s is that you really have to focus
on keeping inflation relatively low over the medium-term,” he said.
“I’d prefer to focus on our medium-term goal of 2%.”
He said Rogoff’s proposal to allow above-target inflation for
awhile and then bring it back down is “much harder to operationalize”
than “in the textbook model.”
“That’s one issue — how you’d actually do it.” Williams continued.
Another is the issue of “credibility … . Can you have higher inflation
and not undermine your credibility.”
Rogoff, former chief economist for the International Monetary Fund,
proposed in a recent Financial Times column that the Fed could try “to
achieve some modest deleveraging through moderate inflation of, say, 4
to 6 percent for several years.”
Williams said that nothing the Fed can do at this point would have
a “hugely powerful” impact, because “monetary policy is not the end-all
and be-all.” But he said the steps proposed by Bernanke “would have
some effect on long-term interest rates.” And he suggested that the FOMC
is obligated by its dual mandate to do its best to ease the pain of the
“patient” as he described the economy.
He noted that the FOMC’s extension of zero rates “through at least
mid-2013″ resulted in lower yields, although he said long rates have
come down primarily because of weak economic data.
Although there are fiscal, regulatory and other impediments beyond
the Fed’s control, this does not mean the Fed should be inactive,
Williams argued.
“We have to work with the hand we’re dealt,” he said. Whether firms
are avoiding hiring and investing because of lack of confidence or
uncertainty or “just lack of demand,” he said the Fed must make monetary
policy the best it can to help achieve its objectives.
Williams estimated that the “natural” or “non-accelerating
inflation rate of unemployment (NAIRU) has risen from about 4 3/4% to 5%
before the recession to about 6 3/4% now. And he said some of this
increase is “structural” — in part related to the extension of
unemployment benefits. He said it will take time to reduce unemployment
to more normal levels and suggested that the Fed needs to do its best to
help that process along because of the potential “scars” of long-term
unemployment.
Earlier, in response to questions from the Rotarians, Williams said
that the Fed is using its supervisory authority to monitor banks’
risk-taking in search of higher yields due to the Fed’s zero rate
policy. And he said it is watching the so-called “carry trade,” i.e.
borrowing at those very low rates and using the money for speculative
purposes.
Although three Fed presidents dissented against the FOMC’s Aug. 9
language change on rates, Williams said he is not concerned about
increased dissension. He said he respects his colleagues’ views and said
all are trying to find the best policy approach. He called the process
“healthy” and not a threat to Fed credibility.
Williams disputed a questioner’s supposition that the U.S.
dollar is in danger of losing its status as the world’s leading reserve
currency.
“The dollar has been a reserve currency for a long time, and I
don’t think that’s going to change anytime soon,” adding to laughter
that “the euro doesn’t seem likely (to supplant the dollar) right
now.”
** Market News International **
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