Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the Fed may have a tough time aiding the economy and reducing a “deeply troubling” unemployment rate through a second round of Treasury purchases.
With financial markets functioning better now than in early 2009, “my own guess is that further uses of QE would have a more muted effect” on narrowing the gap between longer and shorter-term Treasury yields, Kocherlakota said today in a speech in London hosted by the European Economics and Financial Centre, using “quantitative easing” to refer to such purchases.
Kocherlakota devoted almost half his speech to discussing how restarting large-scale purchases of Treasuries could in theory lower interest rates and boost growth without endorsing or opposing the policy. Fed policy makers said Sept. 21 that they are prepared to ease monetary policy if needed, in part to keep too-low inflation from harming the economy.
Gross domestic product “is growing, but more slowly than I expected or than we would like,” Kocherlakota, the newest Fed policy maker, said in prepared remarks. “Inflation is a little low, but only temporarily. The behavior of unemployment is deeply troubling.”
Fed officials are considering ways to bring down unemployment that’s persisted at 9.5 percent or higher for the past year, and Chairman Ben S. Bernanke in August highlighted additional asset purchases as a main option. The Fed purchased more than $1.5 trillion of Treasuries and mortgage debt from January 2009 through March 2010, Kocherlakota said. The policy- setting Federal Open Market Committee next meets Nov. 2-3 in Washington.
Kocherlakota, 46, joined the Minneapolis Fed as its chief in October 2009 and will vote on monetary policy starting in January. He was previously economics professor and department chairman at the University of Minnesota in Minneapolis, where he had taught since 2005. Kocherlakota also worked as a Fed researcher and professor at Stanford University in California.
Kocherlakota joins Atlanta Fed President Dennis Lockhart in publicly contemplating the option of more asset purchases. Lockhart, speaking yesterday in Sewanee, Tennessee, said the debate among policy makers over whether to undertake a new round of buying will “intensify” soon, and officials have the “will to act” as needed to support the flagging U.S. recovery.
Lockhart told reporters that policy makers haven’t agreed on further action and in his view it’s “not a foregone conclusion that more accommodation is required.”
Kocherlakota, discussing other easing options outlined by Bernanke, said changing the FOMC statement to indicate a longer period of a low federal funds rate than the current “extended period” should help lower medium-term and long-term rates.
Reducing the 0.25 percent rate paid on banks’ reserve deposits may have a similar effect without having “much direct effect on loan markets,” he said.
Philadelphia Fed President Charles Plosser and Boston Fed President Eric Rosengren are scheduled to speak today at separate events in the U.S. Rosengren votes on monetary policy this year.
The Fed’s Open Market Committee said after meeting Sept. 21 that the U.S. recovery “is likely to be modest in the near term.” Kocherlakota said the Minneapolis Fed’s economic forecasts from September are “distinctly lower” than August estimates and now show GDP growth of about 2.4 percent in the second half of 2010 and 2.5 percent in 2011.
Inflation, based on the Commerce Department’s personal consumption expenditures price index preferred by the Fed, rose at an annual rate of “just over 1 percent” from the fourth quarter of 2009 through the second quarter of 2010, he said. The bank’s forecasts show inflation returning to the 1.5 percent to 2 percent range next year, Kocherlakota said.
Underlying inflation is “somewhat below” levels consistent with the Fed’s mandate to promote maximum employment and stable prices, the FOMC said last week.
Unemployment is likely to stay above 8 percent “well into 2012,” Kocherlakota said. In June, Fed officials projected it would range from 8.3 percent to 8.7 percent in the fourth quarter of 2011 and 7.1 percent to 7.5 percent a year later.
“The lack of vitality in the U.S. labor market can only be termed disturbing,” Kocherlakota said. One measure he cited was the decline in the seasonally adjusted labor force participation rate in the 12 months through July to 64.6 percent from 65.4 percent, “the biggest July-over-July fall in the 60-plus-year history of that statistic.”
Some economists expect the Fed to take new policy action, such as large-scale asset purchases, to lower interest rates, aiming to boost growth and keep inflation from declining too much. Central bank officials will present updated projections for GDP, unemployment and inflation at the November meeting.
Quantitative easing can influence the economy in four ways: signaling the Fed will keep the benchmark rate low for longer, adding bank reserves that can add to money creation, reducing the private sector’s exposure to interest-rate risk and shifting that risk to taxpayers, Kocherlakota said.
With about $1 trillion of excess reserves, banks are “not using a lot of their existing licenses to create money,” he said. “QE gives them new licenses to create money, but I do not see why they would suddenly start to use the new ones if they weren’t using the old ones.”
Kocherlakota said Sept. 8 he would have voted for the Fed’s decision last month to reinvest maturing mortgage bonds into Treasuries as a way to sustain economic growth. A decline in long-term assets on the Fed’s balance sheet could have been “a drag on the recovery,” Kocherlakota said earlier this month in Missoula, Montana.
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