Fed trio spars on low-rate policy ahead of December meeting

CHICAGO Sun Dec 2, 2012 8:40am IST

A view shows the Federal Reserve building on the day it is scheduled to release minutes of the Federal Open Market Committee from August 1, 2012, in Washington August 22, 2012. REUTERS/Larry Downing/Files

A view shows the Federal Reserve building on the day it is scheduled to release minutes of the Federal Open Market Committee from August 1, 2012, in Washington August 22, 2012.

Credit: Reuters/Larry Downing/Files

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CHICAGO (Reuters) - Three top Federal Reserve officials on Saturday offered sharply different takes on the U.S. central bank's unprecedented efforts to push down long-term borrowing costs, highlighting what may be some key themes at the Fed's upcoming policy-setting meeting.

Charles Evans, the dovish president of the Chicago Fed, made no bones about his view that more policy accommodation is needed, repeating his call for keeping rates low until unemployment falls to at least 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent.

"We are in a period where having low policy rates for a very long time would be helpful," he said at panel at the University of Chicago sponsored by the university's Becker Friedman Institute for Research

Also on the panel, which was held ahead of the Fed's December 11-12 closed-door policy meeting, were Charles Plosser, the hawkish president of the Philadelphia Fed, and Minneapolis Fed President Narayana Kocherlakota -- a former advocate of policy tightening who in September began calling for further easing.

Showing a series of slides to a mostly student audience, Evans argued that high joblessness now means that even with interest rates kept low for years, inflation is unlikely to rise above 2.3 percent.

But Plosser, seated between Evans and Kocherlakota on the panel, said he is worried that the continuing high unemployment rate may mean the Fed's policies are not working as expected.

With unemployment at historically high levels - it ticked up to 7.9 percent in October -- and inflation low, policymakers could "walk away from that evidence and say, either we haven't done enough, or we haven't got the right model of how the transmission mechanism is working," Plosser said.

He also expressed concern about reversing the Fed's longstanding low-rate policy. Although the Fed has the tools to raise rates, he said, "History suggests that it's always been easier for the Fed to lower rates than to raise them."

The Fed has kept short-term rates almost at zero percent since December 2008 and has bought some $2.5 trillion in bonds to drive down longer-term borrowing costs and boost the recovery from recession.

It has also said it expects to keep rates low until at least mid-2015, as it works to bring down too-high unemployment.

Since September the Fed has been buying a total of $85 billion in long-term securities each month to help push down borrowing costs. Part of that is the program known as Operation Twist, in which the Fed buys $45 billion in longer-term Treasuries and sells the same amount of shorter-term ones.

Twist expires at year end, and officials will need to decide at their December meeting whether to ramp up the quantitative easing program, dubbed QE3, to make up for the shortfall.

Under QE3, the Fed has said it would buy $40 billion in mortgage-backed securities per month until the outlook for the labor market improves substantially.


The three policymakers on Saturday gave no hint as to their views on what the Fed should do, although Evans has previously advocated for keeping asset purchases at a monthly rate of $85 billion, while Plosser has said he does not view Twist's expiration necessarily as tightening.

Instead, the three debated the merits of adopting thresholds for inflation and unemployment as guideposts for policy. Fed officials have been discussing such plans for months, although few economists believe they will come to a decision in December.

"I'm terribly worried that we are asking too much of policy here," Plosser said, of the value of setting thresholds. "I'm worried that the strategies are going to sow more confusion than clarity."

Kocherlakota, like Evans, reiterated his support for a threshold-based policy. The Minneapolis Fed chief -- who, like Plosser, did his graduate training in economics at the University of Chicago -- repeated his call for the Fed to keep rates low until the jobless rate reaches 5.5 percent or even below, as long as inflation does not threaten to rise above 2.25 percent.

Such a promise is "credible," he said, because it shows investors the Fed will not sacrifice price stability in order to reduce unemployment. The Fed in January set an inflation target for the first time, aiming at 2 percent inflation.

"I think we are falling short on both metrics, more so on employment than inflation," he said, referring to the Fed's mandates to keep prices stable and to maximize employment.

Evans also emphasized his "inflation safeguard" of 2.5 percent, saying that if he is wrong and easier monetary policy is not the answer to unemployment, inflation will rise, and the Fed can then take its foot off the gas pedal.

Plosser said he was "dubious." The public could easily misinterpret an inflation "threshold" as a target that conflicts with the Fed's newly adopted 2 percent inflation goal, he said.

"I am worried that the commitment we have is not credible, or is not well understood, and we won't get the effects that these models tell us," Plosser said. (Reporting by Ann Saphir; Editing by Leslie Adler)

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