The US Federal Reserve must not launch a new round of asset purchases without setting out what they are meant to achieve, the president of the Philadelphia Fed has warned in an interview with the Financial Times.
“I think that before we engage (in further quantitative easing) we need to be very clear about what it is we’re trying to do, how we’re going to go about doing it, how we’re going to measure whether we’re effective at it or not, and how we’re going to communicate that,” said Charles Plosser, who opposes a second round of quantitative easing – nicknamed “QE2” – at this point.
Mr Plosser’s comments highlight one of the main concerns of QE2 sceptics at the Fed: that the central bank will make an implicit promise to use asset purchases to manage the unemployment rate, which they do not believe it can successfully do.
The Federal Reserve is pondering whether to restart asset purchases after the economic recovery slowed to a pace that leaves inflation below its comfort zone and unemployment stuck at 9.6 percent.
Mr Plosser is one of a number of sceptics at regional Fed banks but they are unlikely to sway the rate-setting committee if chairman Ben Bernanke argues for action.
Mr Plosser’s remarks also show that debate at the Fed over how to communicate QE2 – if it goes ahead – is at least as intense as over how large it should be.
That is because the effects of QE2 would be shaped by perceptions about what the Fed intends to do in the future.
In a speech last week, William Dudley of the New York Fed said that adopting a more explicit inflation goal, like the numerical targets used in countries such as the UK, could complement further asset purchases.
Mr Plosser is a long time proponent of inflation targeting and said that he would be willing to consider asset purchases if they were tied to such a goal and necessary to achieve it.
Mr Plosser has further grounds for his opposition to QE2 at this point.
First, his own forecast is that inflation will rise towards 2 percent in 2011, and he is less concerned by the risk that growth or inflation will weaken further than some of his colleagues.
Second, he doubts the efficacy of QE2 in bringing down long-term real interest rates, and the effect of lower long-term rates on unemployment.
“Long-term rates have already come down over 100 basis points since the spring and we did nothing.
So what makes us think that another 20 basis points is going to make any difference whatsoever?” he said.
Third, he worries about whether the Fed will be able to withdraw the extra funds that it supplies to banks smoothly when the time comes.
Finally, he does not think that the cost of disinflation or deflation is too high, provided that the public continues to expect inflation in the future.
“One month or two months of deflation really isn’t the end of the world.”