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The Fight at the Fed: Wizard of Oz Roars, Clicking Heels Won't Restore Growth


Two Federal Reserve Bank presidents delivered policy speeches on Wednesday that expressed highly divergent views of monetary intervention. Eric Rosengren, president of the Federal Reserve Bank of Boston, and Charles Plosser, the president of the Federal Reserve Bank of Philadelphia delivered their remarks at separate events.

Charles I. Plosser, President and CEO of the Federal Reserve Bank of Philadelphia

Their speeches seem to sum up two broad views of economics and governance: On the one hand, that government should take continued and innovative action to support the financial markets and the economy as a whole; and on the other, that government’s ability to improve the economy in a highly targeted and meaningful way through policy shifts is limited.

Rosengren is firmly in the first camp. He summed up his position in the intervention debate this way: “These days, as in past recoveries, it is not uncommon to hear some observers say that there is little that policymakers can or should do. This is not my perspective” Rosengren went on to further elaborate his position by saying that policy makers should respond to a slow recovery “vigorously, creatively, thoughtfully, and persistently, as long as we have options at our disposal.”

Reading tea leaves with regard to Federal Reserve officials’ remarks can be something of a sport, but Rosengren’s meaning seems fairly clear: Governments can and should exercise their prerogative to intervene in the economy; take unconventional action when necessary; and, when in doubt, keep taking additional action.

Plosser does not share Rosengren’s view, as he made clear in his remarks yesterday: “Can monetary policy help speed up such adjustments [as the shrinking of the job market in certain sectors]? It may be tempting to think so, but monetary policy is not a magic elixir that can solve every economic ill.” Plosser continues, “While the Fed’s actions can help encourage spending and borrowing, monetary policy is not designed to fine tune employment nor can it solve the sorts of geographic, sectoral, or skill mismatches I have just discussed.”

The monetary policy that Rosengren and Plosser are referring to is executed by the Federal Open Markets Committee (FOMC) of The Federal Reserve. Membership on the committee consists of the seven members of the Federal Reserve Board, who are appointed by the president; the president of the New York Fed; and four of the regional Reserve Bank presidents, who serve on a rotating basis. Rosengren is currently a member of the FOMC, while Plosser is an alternate.

Much of the implicit debate in Rosengren and Plosser’s policy positions seems to involve the value of quantitative easing (QE) policy, where central banks buy assets with money they have created.

(Quantitaive easing is sometimes referred to as “unconventional” policy, in contrast with The Fed’s ability to set interest rate targets and control bank’s reserve requirements.)

Quantitative easing becomes of particular importance in an economy where interest rates are very low, such as in the current environment, because a point is reached where rate targets can no longer be lowered — interest rates cannot drop below zero — and additional mechanisms of monetary stimulus are sought. Overreliance on this practice of expanding the money supply is controversial among some economists because of the belief that economic stimulus through QE is a slippery slope to high levels of inflation and fiscal irresponsibility.

As Plosser puts it, “History and economic theory teach us that it is far too tempting for governments to print money as a substitute for facing the hard choices of cutting spending or increasing taxes.”

Rosengren, however, seemed to lend his support to The Fed’s use of QE by praising its impact in limiting the damage of the current recession, “Fortunately, the Federal Reserve had already begun to ease — and continued to ease quite dramatically... “He goes on to say, “While it [The Fed’s monetary policy] could not offset the effects of the severe problems emerging in the economy, the policy stance was more responsive than if it had been in synch with most private forecasts at the time. This policymaking was key to avoiding far worse outcomes.”

Rosengren goes on to say “One of the challenges is that with unconventional policies [QE], costs can be apparent but benefits more indirect, and harder to track.” He seems to be anticipating the counter arguments of those sympathetic to Plosser’s position, acknowledging the costs of printing money, but arguing for the necessity of unconventional monetary policy in times of financial disruption.

Plosser leaves little doubt about his position on continued quantitative easing: “Thus, it is difficult, in my view, to see how additional asset purchases by The Fed, even if they move interest rates on long-term bonds down by 10 or 20 basis points, will have much impact on the near-term outlook for employment.”

Essentially, Plosser’s position is that the potential benefits of QE at this time are quite low and, as he already made clear, are far outweighed by their significant cost.

But Plosser’s most interesting commentary on The Federal Reserve

System comes near the end of his speech: “The Fed must be credible. Protecting that credibility is why, based on my current outlook, I do not support further asset purchases of any size at this time. As I said earlier, asset purchases in our current economic environment can do little if anything to speed up the return to full employment. But if the public believes that they can and is disappointed, it may have less confidence that the Fed will act to raise inflationary expectations if needed.”

Plosser seems to be suggesting that the Fed’s powers are of a kind of Wizard of Oz nature: The Fed is powerful because we believe it to be.

Do Plosser’s concerns about continuing quantitative easing result strictly from a rational cost-benefit analysis of expanding the money supply — or is he afraid of what we might see if The Fed were to pull back the curtain?

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