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Fed’s Plosser: Time to Tighten Policy ‘Not Too Distant’

Thursday, 12 May 2011 12:09 PM

Federal Reserve Bank of Philadelphia President Charles Plosser said the U.S. economic recovery is nearing a point where the central bank should begin pulling back record stimulus.

“If the economy continues to make progress, then monetary policy will need to exit from its extraordinary accommodation in the not-too-distant future,” Plosser said today in a speech in Aventura, Florida.

“While my expectation is that oil-price increases will level off and that the currently elevated inflation measures will reverse, the risks to the inflation outlook are tilted to the upside,” requiring that the Fed have a plan for tightening, he said.

Chairman Ben S. Bernanke and the Federal Open Market Committee, of which Plosser is a voting member, pledged at a meeting last month to complete a $600 billion bond-purchase program in June. The Fed hasn’t set out a timeline for shrinking its $2.7 trillion balance sheet or raising rates from the zero- to-0.25 percent range that’s been in place since December 2008.

“Depending on how economic conditions evolve, we must be prepared to act as aggressively as necessary if we are to promote effectively our long-run goals of price stability and maximum employment,” Plosser said.

Fed officials have proposed a variety of so-called exit strategies. Bernanke said last month that ceasing to reinvest maturing assets on the Fed’s balance sheet is “very likely” to be an early tightening step. Minneapolis Fed President Narayana Kocherlakota said he prefers raising the central bank’s target interest rate as the first move.

QE3 Unlikely

Speaking to reporters after the speech, Plosser said the Fed is “actively discussing” its next steps and that a third round of quantitative easing, or QE3, is unlikely. Plosser said that the FOMC may “go on hold” to assess the economy.

“We’ve made pretty clear there’s no QE3 on the table right now,” he said, “unless something dramatic happens.”

The end of the Fed’s $600 billion bond purchase program next month is “all built into the market,” since the Fed has not altered its plan since it was first announced in November, Plosser said. “I don’t think there’s going to be any disruptive effects.”

In a March speech called “EXIT,” Plosser called for a plan to sell $125 billion in assets for every 0.25 percentage point increase in the Fed’s interest rate.

‘Systematic Plan’

“We can be most successful in exiting from this period of extraordinary accommodation and nontraditional policies if we communicate a systematic plan that describes where we are headed and how we will get there,” Plosser said today at the annual conference of the New Jersey Bankers Association. He also repeated his call for the Fed to adopt an explicit target for inflation, to help anchor public expectations during the exit.

The national average price of gasoline has risen 36 percent in the past year to $3.95 a gallon on May 9. The Labor Department reported May 10 that import prices rose 11 percent in April from a year earlier.

The Fed said such pressures will have only a “transitory” effect on overall inflation. The Labor Department said overall prices rose 2.7 percent in March from a year earlier, and prices excluding food and fuel rose 1.2 percent. The Fed targets inflation of 2 percent or a bit below.

While Plosser said inflation from oil prices will likely wane, he noted increasing input costs for companies, saying “I expect more firms will test their pricing power, particularly as concerns about the recovery’s sustainability abate.”

‘Upside’ Risks

“Thus, I see the inflation risks as being clearly to the upside,” he said.

Plosser also said he was concerned about the stability of inflation expectations.

“It is somewhat troubling to me that expectations of inflation in the medium to longer term are moving up and down as much as they are,” he said. “It suggests that the public and the markets may not have as much confidence in the Fed’s ability or willingness to keep its price-stability mandate clearly in focus.”

Longer-run inflation expectations, as measured by the spread between Treasury Inflation Protected Securities and nominal bonds, show investors expect inflation of 2.85 percent in five to 10 years, up from 2 percent as recently as August. The measure climbed as high as 3.19 percent last month.

Economy to Grow

Plosser said he forecasts the economy will grow 3 percent to 3.5 percent in both 2011 and 2012 and expects the unemployment rate to fall to 8.5 percent at the end of this year and to 7 percent to 7.5 percent by the end of 2012.

Speaking to reporters after the speech, Plosser said he sees inflation drifting up toward 2 percent this year and that “if that forecast is true, then I wouldn’t be surprised if we had to take some action before the end of the year.”

Plosser, 62, voted to complete the central bank’s $600 billion of bond purchases and backed its decision to keep interest rates “exceptionally low” for an “extended period.” In 2008, he dissented twice in favor of less monetary stimulus.

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Federal Reserve Bank of Philadelphia President Charles Plosser said the U.S. economic recovery is nearing a point where the central bank should begin pulling back record stimulus. If the economy continues to make progress, then monetary policy will need to exit from its...
Thursday, 12 May 2011 12:09 PM
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