--Richmond Fed's Lacker Says Start Selling MBS, Halt Reinvestment Now --SF Fed's Williams Says More Resilient Econ Lets Fed Take Foot Off Gas
By Steven K. Beckner
PALO ALTO, CALIF. (MNI) - A trio of Federal Reserve Bank Presidents differed on the pace of monetary tightening and the management of the Fed's balance sheet, but otherwise found much to agree about at a joint press conference Friday.
The three - Richmond's Jeffrey Lacker, Philadelphia's Charles Plosser and San Francisco's John Williams - saw eye to eye about continuing the phase-out of large-scale asset purchases to completion, among other things, as they spoke to reporters following a two-day conference sponsored by Stanford University's Hoover Institution.
But they parted ways on when the Fed should start shrinking its balance sheet - and the $2.6 trillion pile of excess reserves.
When the Fed's policymaking Federal Open Market Committee outlined a set of exit principles in June 2011, one of them was that, before the Fed starts raising the federal funds rate, it would stop reinvesting principal payments from its holdings of agency debt and agency MBS and stop rolling over maturing Treasury securities at auction to prevent any passive shrinkage of its balance sheet.
But more recently, many Fed officials have had a change of heart, and New York Fed President William Dudley declared last week that reinvestment should not be halted until after the FOMC starts raising rates.
Lacker, admitting he is "in a distinct minority," said that if it was up to him, he "would start selling (mortgage backed securities) right now, and stop reinvesting Treasury proceeds."
Williams made clear he disagreed.
Plosser, an FOMC voter this year, said he is "not sure it makes that much difference at the end of the day" when reinvestment and rollover policies are suspended. He said the timing is "open to discussion."
But he said the Fed "should restructure" its balance sheet, shrink it and "return to all Treasuries...sooner rather than later."
Plosser said the FOMC has many different options. He said the Fed could "stop reinvesting first and not sell anything."
Or, he continued, if the FOMC decides to keep a large balance sheet, it could decide to "change the reinvestment policy from reinvesting in long-term bonds and long-term MBS...and reinvest in short-term Treasuries instead of long-term."
Doing so would "make it easier to unwind (the balance sheet) down the road," he added.
Williams said the reinvestment policy is "not that important." He called it "a second order policy decision... once the process of raising interest rates is in place."
But Lacker, harkening back to the original exit principles, cautioned the FOMC "shouldn't change course lightly, if you want to be taken at your word in the future."
Williams, who was Fed Chair Janet Yellen's top policy advisor when she was San Francisco Fed president and is sometimes regarded as "a dove," did not say when or by how much the Fed should raise interest rates. But he said that, with the economy showing "resilience," the Fed "can start pulling our foot off the gas."
Williams added "our policy is working well."
Plosser, who has a more "hawkish" reputation, concurred saying "it's important to recognize that as our economy gets closer to our objectives, as inflation begins to close the gap (between where it is and the 2% target), as the labor market continues to improve, we should be contemplating adjusting policy to recognize that we're closer to our goals than before."
Some have expressed concern the Fed might have difficulty raising the interest rate on excess reserves sufficiently as the cost of doing so rises and the Fed suffers capital losses on its securities portfolio.
But all three Fed presidents said capital losses should be considered "inconsequential," at least in terms of the consolidated government balance sheet. As Lacker said, "the Fed's loss is the Treasury's gain."
Lacker cautioned, however, that raising IOER payments to banks could be "a communications challenge" for the Fed.
"The optics are going to provide an opportunity for demagoguery," he elaborated, warning IOER hikes could occasion "simple-minded characterizations of what we're up to..., an opportunity for people to raise suspicions."
"We will need to be very careful," Lacker said. "We will need to be forthright and clear."
Plosser said the Fed's success in controlling inflation and improving labor markets should aid the Fed in its tightening efforts, but he warned that large and growing interest payments to banks "will not go unnoticed" in places like Congress.
"It will be a challenge for our communication," he agreed, but "what's most important is how we respond...," he went on. "The danger is that we'll let that (opposition to IOER hikes) deter us from making the right policy decision going forward."
If the Fed does not resist political pressure, "if we're not successful in conducting policy the way we should and we pull back that could be consequential."
"A fear of realizing capital losses is no reason to alter plans for asset sales," Lacker said.
Plosser also cautioned that "the exit runs the risk of being kind of bumpy; if markets decide that rates need to go up we may find ourselves chasing rates up."
He said the Fed should not feel forced to raise rates faster "just because the markets are putting us in that position."
Williams warned that financial markets are subject to wild swings in their rate expectations.
Richmond's Lacker said it will be important for the Fed to read signals from long-term interest rates, for example assessing whether a rise in rates reflects increased inflation fears or just stronger economic activity and demand for capital.
The three Fed presidents were asked whether the FOMC should add "financial stability" to its mandate, but none of them seemed eager to take that on, while acknowledging that the Fed needs to monitor risks to financial stability.
Williams and Plosser agreed financial stability issues are "not constraining" monetary policy at the moment.
Most important, Plosser said, is that the Fed not let monetary policy become "a source of financial instability."
Williams downplayed the FOMC participants' projections of "appropriate" monetary policy, emphasizing that the "dots" in the Summary of Economic Projections representing different funds rate levels are subject to change.
But Lacker said he takes the funds rate projections more seriously. He said the dots should be "based on a pattern of (Fed) behavior that I want people to believe we're committed to."
Much of the Hoover Institution conference was devoted to the question of whether the Fed should follow a monetary policy rule, with Plosser pushing particularly hard for the adoption of a Taylor Rule.
Williams, a former student of Stanford Professor and conference host John Taylor for which the rule is named, noted during a panel discussion that since the mid-1990s, the rule has been used extensively by the Board staff in developing monetary policy alternatives.
Lacker told reporters, "I view our behavior as pretty close to the Taylor Rule," which calls on the Fed to raise or lower the funds rate to the extent that inflation and/or GDP growth vary from certain norms.
But Plosser said the problem is that, although the Taylor Rule is used in staff and FOMC analysis, it has not been integrated into FOMC communications.
"While it is correct that the FOMC does consider and look at a variety of rules, nowhere is that information reflected in any of our communications," he said.
Williams said that, once the Fed gets beyond the zero lower bound, he hopes the Fed will get back to a more "systematic" rules-based monetary policy approach.
Although housing has slowed in recent months, due to higher mortgage rates, Williams said he remains "optimistic."
--MNI Washington Bureau;tel: +1 202 371-2121; email: kmracek@mni-news.com