Written on January 17, 2011
Federal Reserve Bank of Philadelphia President Charles Plosser said that while unemployment will probably stay too high for the foreseeable future, he hasn’t ruled out favoring a rate increase this year should economic growth warrant such a move.
“If economic growth in the United States continues to gain traction and the prospects begin to look ever better, it might be time for us to begin thinking about how do we begin to gradually take our foot off the accelerator,” Plosser said today to reporters after a speech in Santiago. Asked if the recovery may improve enough this year that he’d want to begin a policy tightening, he said, “It might. I’m not going to rule that out.”
The Federal Open Market Committee signaled last month that it will press ahead with its plans to buy $600 billion of bonds through June until many of the 15 million of unemployed Americans find work, according to the minutes of their Dec. 14 meeting.
Plosser, who votes this year on the FOMC, said the so- called quantitative easing program will probably conclude at the end of June as scheduled.
“It could end earlier if economic conditions call for it, but right now I’m not sure that that’s the most likely outcome,” he said to reporters. “It obviously creates challenges for some countries because of appreciating currencies. But I think that will pass. Those are short-run issues.”
The Philadelphia Fed chief has previously expressed skepticism about the ability of quantitative easing to spur growth and bring down a jobless rate that’s been stuck at or above 9.4 percent since May 2009. He said today that monetary policy can’t “retrain a workforce” or reallocate jobs.
“Most economists now understand that, in the long run, monetary policy determines only the level of prices and not the unemployment rate or other real variables,” he said. “Any boost to the real economy from stimulative monetary policy will eventually fade away as prices rise and the purchasing power of money erodes in response to the policy.”
Monetary policy should focus on price stability and efforts by the Fed to do “too much” may damage the central bank’s credibility, Plosser said in the speech.
“Monetary policy is not going to be able to speed up the adjustments in labor markets or prevent asset bubbles, and attempts to do so may create more instability, not less,” Plosser, 62, said. “Expecting too much of monetary policy will undermine its ability to achieve the one thing that it is well- designed to do: ensuring long-term price stability.”
The Fed’s quantitative easing program, dubbed “QE2” by analysts and investors, has aroused the harshest political backlash against the central bank in decades. Some politicians have said the program risks sparking an outbreak in inflation and have called for stripping the Fed of its goal of full employment, leaving the central bank only to focus on price stability.
Plosser said that the central bank should adopt and announce an explicit inflation target, which would help “the public and the markets understand and better predict how policy will evolve as economic conditions change.”
The Fed shouldn’t target asset bubbles because it’s “no easy task” for officials to identify mispriced markets, Plosser said. Monetary policy is too “blunt” a tool to realign specific prices, he said.
Last Resort Lender
When the central bank must act as a lender of last resort, it should establish a “rule-like or systematic approach” that it adheres to in crisis, Plosser said. Putting taxpayer funds at risk is “better thought of” as fiscal policy, and having the central bank do so invites political interference, he said.
“Having crossed the Rubicon into fiscal policy and engaged in actions to use its balance sheet to support specific markets and firms, the Fed, I believe, is likely to come under pressure in the future to use its powers as a substitute for other fiscal decisions,” Plosser said.