By Greg Robb, MarketWatch
WASHINGTON (MarketWatch) — The Federal Reserve’s efforts to buy up assets to bring down long-term interest rates and spur the economy is very risky, Charles Plosser, the president of the Philadelphia Federal Reserve Bank, said Thursday.
“I believe the extraordinary policies the Fed has pursued pose substantive longer-term risks,” Plosser said in a speech at the libertarian Cato Institute.
Plosser is a long-standing opponent of the Fed’s bond-buying plans, known as quantitative easing. In September, the Fed launched a third round of asset purchases, popularly known as “QE3,” to purchase $40 billion in mortgage backed securities per month.
The plan is open-ended, with the Fed saying it won’t stop until there is substantial improvement in the labor market.
Plosser’s criticism carry some weight, as he is a leading expert on monetary policy.
Plosser said the Fed’s decision to buy mortgage-backed securities to help the housing market might lead investors to think the central bank will always rush to the aid of the housing industry in future downturns.
“Will investors in other markets expect similar treatment and therefore be encouraged to take excessive risk?” Plosser asked.
Another worry is that the Fed might have to aggressively sell the housing-related assets quickly at some point to contain inflation.
“The bigger our balance sheet, the more difficult it will be to exit in a way that meets our inflation objective without creating instability in the real economy, thereby undermining our credibility and reputation,” he said.
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“It is a fairly risky monetary policy. The longer-term might not be so rosy,” he said
Plosser was also sceptical that QE3 is going to help bring down the unemployment rate.
“The ability of monetary policy to influence employment has long been recognized as tenuous at best,” he said.
Plosser said that some of the recent economic data, including upward revisions to job growth in the summer months as seen in the October job report, suggest that the economy might be “a little bit better” that had been previously thought.
But uncertainty over tax policy is still making businesses “sit on their hands,” he said.
Rules not thresholds
The Philadelphia Fed president also disclosed that he is advocating the central bank adopt a rule for monetary policy to decide when the first rate hike will be needed, instead of relying on numerical thresholds about unemployment and inflation.
Policy rules, like the well-known “Taylor Rule,” prescribe changes in short-term interest rates when inflation and unemployment move from normal levels.
Earlier this week, Federal Reserve Vice Chairwoman Janet Yellen threw her support behind proposals that would set a level of unemployment or a level of inflation that would have to be crossed before the Fed hikes short-term interest rates.
At the moment, the Fed is using a calendar-date approach, saying it expects to keep rates steady until mid-2015.
Plosser said such thresholds for the first rate hike might be confused with other thresholds for when QE3 would end, effectively opposing both the calendar-based guidance and Yellen’s proposal.
“I think we have a big communications problem here,” Plosser said.
