SAN FRANCISCO, July 2 (Reuters) - The U.S. Federal Reserve is prepared to take away the “punch bowl” of easy monetary policy when the time comes, although getting the timing right while keeping inflation low will be a tough job, a top Fed official said on Monday.
“This time, it will be especially challenging, given the extraordinary depth and duration of the recession and recovery,” San Francisco Federal Reserve Bank President John Williams said in remarks prepared for delivery to the Western Economic Association International. “The Federal Reserve is prepared to meet this challenge when that time comes.”
Williams’ comments largely focused on why the Fed’s unprecedented easy monetary policy has not so far led to inflation, and on the U.S. central bank’s tools to keep inflationary pressures in hand even if the economy begins to hum strongly again.
But his remarks about the Fed’s possible exit strategy, at a time when many economists and traders are betting on renewed Fed easing to fight a slowing recovery, are a surprise.
Chicago Fed President Charles Evans in an interview last week declined to talk much about the Fed’s exit strategy, saying that doing so could give the impression the Fed was closer to tightening monetary policy than it is, given the weakness of the economy.
Williams, often seen as a policy dove, votes on the Fed’s policy-setting panel this year and has supported the Fed’s near-zero interest-rate policy and its purchases of securities to boost the economy.
Banks, households and business are hoarding cash rather than lending, borrowing or spending it, he said in his prepared remarks, keeping inflationary pressures from building up.
Inflation has hovered near the Fed’s 2 percent target for the last four years, even as the Fed has kept interest rates near zero and bought $2.3 trillion in securities to push down borrowing costs and boost the economy.
Some economists and even fellow Fed officials have worried that once the economy begins to improve, banks will start lending more actively, and inflation will inevitably result.
That will not happen, Williams said, because the Fed now pays interest on the excess reserves that banks hold at the central bank, and by raising that rate, can trap money that might otherwise be lent out too rapidly.
“The world changes if the Fed is willing to pay a high enough interest rate on reserves,” Williams said. The Fed could also reduce its holdings of long-term securities to remove accommodation, he said.
“In thinking of exit strategy, the nature of the monetary policy problem the Fed will face is no different than in past recoveries when the Fed needed to ‘take away the punch bowl,'” he said. “Of course, getting the timing just right to engineer a soft landing with low inflation is always difficult.”