Philadelphia Fed President: Fed Should Taper QE

Federal Reserve Bank of Philadelphia president Charles Plosser said the central bank should slow the pace of quantitative easing because the potential costs from more stimulus outweigh the benefits.

“We should begin to taper our asset purchases with an aim of ending them before yearend,” Plosser said today in a speech prepared for delivery in Lancaster, Pa. “With interest rates already extremely low and the Fed’s balance sheet large and growing, monetary policy is posing risks to the economy in terms of financial stability, market functioning and price stability.”

The Federal Open Market Committee is debating how long it should continue $85 billion in monthly purchases of Treasuries and mortgage bonds aimed at boosting economic growth and reducing 7.9% unemployment. Chairman Ben Bernanke and vice chairman Janet Yellen in speeches this month affirmed a commitment to record stimulus pushing the central bank’s balance sheet beyond $3 trillion.

Even with the easing, the economy expanded just 0.1% in the fourth quarter amid the biggest drop in defense spending since the closing years of the Vietnam War.

“Beneath the very weak headline number, there were some signs of improvement in consumption, business investments and residential investments,” Plosser said. “Thus, there is reason to be somewhat optimistic for the coming quarters.”

The Philadelphia Fed chief predicted economic growth of about 3% this year and next. Economists expect the U.S. to expand at a 1.8% rate this year before growth accelerates to 2.7% next year, according to the median of 77 forecasts in a Bloomberg survey.

Plosser, who doesn’t hold a vote this year on the policy-setting FOMC, said accommodation may be fueling excessive risk-taking and that financial instability may “arise from the higher levels of interest-rate risk” taken by investors. The Fed’s expanding role in the mortgage-bond market may also “distort the functioning” of the market over time, he said.

“Our current, increasingly accommodative monetary policy has the potential to complicate the Fed’s exit from the nontraditional policies and undermine its ability to achieve long-run price stability,” Plosser said. While the Fed has the tools to withdraw stimulus in a high-reserves environment, “there remains some uncertainty about their effectiveness, since we do not have historical experience.”

The Fed may take losses on its holdings when interest rates rise, which would not “go unnoticed” and may pose a threat to the central bank’s independence should lawmakers seek to interfere with monetary policy as a result, he said.

Plosser said Feb. 13 he expects the unemployment rate to decline close to 7% by the end of the year, warranting a reduction in the Fed’s monthly bond purchases. The jobless rate rose to 7.9% in January. It has fluctuated between that level and 7.8% since September.

“My forecast of 3% growth should allow for continued improvements in labor market conditions, including a gradual decline in the unemployment rate, similar to the improvements we have seen over the past two years,” Plosser said. He predicted inflation will be near the Fed’s 2% goal during the medium to longer term.

The central bank in December linked the benchmark interest rate to economic indicators for the first time, pledging to hold rates near zero as long as projected inflation doesn’t exceed 2.5% and unemployment exceeds 6.5%.