Tags: fed | federal | reserve | easing | monetary | policy | bernanke

Fed’s Plosser Skeptical of Quantitative Easing

Sunday, 13 Feb 2011 03:00 PM

Charles Plosser, a Fed member who voted against the central bank’s second round of quantitative easing, said in an interview that he is carefully watching for signs of building inflation and warned that the danger of out-of-control prices is real.

"We have all these excess reserves sitting in the banking system, a trillion-plus excess reserves," he told The Wall Street Journal. Plosser is president of Philadelphia’s Federal Reserve Bank. "As long as (the excess reserves) are just sitting there, they are only the fuel for inflation, they are not actually causing inflation. But they could, because when banks convert those excess reserves into loans … we could see a very rapid increase in liquidity."

Plosser said he is carefully reviewing data, such as the Philadelphia Fed business outlook survey, for signs that manufacturers are raising prices. Generally, sellers of goods are slow to pass along price increases until they feel consumers are ready to spend, he noted.

But it’s a rapid rise in new bank loans using the Fed’s trillion-plus that would have him most concerned.

"That would be a very important signal, to me, that we are going to have to start reining in those excess reserves. Otherwise, if they flow out too rapidly, we will potentially face some serious inflationary pressures,” Plosser said.

Greater expectations of inflation, he warned, can by itself create inflation.

If emboldened banks were to turn on a dime and increase their lending overnight, the Fed might be forced to raise rates quickly to compensate, Plosser said. Right now, banks get 0.25 percent for leaving the money at the Fed.

One way to avoid a general rate hike is for the Fed to raise the interest rate it pays to banks on excess reserves. But it might have to do both—raise the rate it pays banks and raise the benchmark rate—to stem new lending.

If the interest rate rose quickly, nearly all credit, like mortgages and consumer loans, would suddenly cost a lot more, crimping recovery. On the flip side, retirees and savers would be rewarded for taking money out of speculative assets like stocks and instead buying bonds or bank CDs again.

“Maybe it will be just gradual. But the risk is that we'd have to raise rates really quickly,” Plosser said.

In that scenario, rising rates would be taken as Fed sabotage of the recovery, creating political pressure on the central bank to fall back and help keep the recovery going, Plosser pointed out. "So then the Fed is faced with a situation whether it's either going to fight that political battle and say 'We don't care, we have to do this.' Or it's going to tolerate more inflation" by refusing to act.

Plosser said that risk means that he prefers to focus on growth rates—growth in the economy, in jobs, in prices and even expectations of higher prices—than the “slack” in the economy preferred by Fed Chairman Ben Bernanke, an indicator Plosser said he “doesn’t believe in.”

“By looking at growth rates, you react earlier," Plosser said.
A quick rise in interest rates would hit mortgage costs very quickly. The 30-year mortgage rate recently topped 5 percent for the first time in nine months.

The Obama administration also just proposed that the federal government wind down housing giants Fannie Mae and Freddie Mac, making the U.S. housing finance system mostly private. Today, the two agencies back 97 percent of home loans.

If Congress approves the plan, the cost of a mortgage would rise by 2 percentage points, according to private banking analysts.

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Charles Plosser, a Fed member who voted against the central bank s second round of quantitative easing, said in an interview that he is carefully watching for signs of building inflation and warned that the danger of out-of-control prices is real. We have all these excess...
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2011-00-13
Sunday, 13 Feb 2011 03:00 PM
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