Tuesday, September 25, 2012

Philly Fed Prez: QE Exit Plan Ends Badly

Philly Fed Prez: QE Exit Plan Ends BadlyAs I stated in the recent article entitled More Importantly From The Romney Vid: Upcoming Failed Treasury Auction, John Whitehead, former head of Goldman Sachs and the New York Fed, stated that the government is running out of buyers of its debt, and that will cause interest rates and inflation to increase. Well, today the head of the Philly Fed, Charles Plosser, admitted that the Fed's QE exit plan is risky and will also likely also lead to greater inflationary pressures, to be felt perhaps as soon as 2015:
I have been a student of monetary theory and policy for over 30 years. One constant is that central banks tend to find it easier to lower interest rates than to raise them. Moreover, identifying turning points is difficult even in the best of times, so timing the change in the direction of policy is always a challenge. But this time, exit will be even more complicated and risky. With such a large balance sheet, our transition from very accommodative policies to less accommodative policies will involve using tools we have not used before, such as the interest rate on reserves, term deposits, and asset sales. Once the recovery takes off, long rates will begin to rise and banks will begin lending the large volume of excess reserves sitting in their accounts at the Fed. This loan growth can be quite rapid, as was true after the banking crisis in the 1930s, and there is some risk that the Fed will need to withdraw accommodation very aggressively in order to contain inflation. At this point, it is impossible to know whether such asset sales will be disruptive to the market. A rapid tightening of monetary policy may also entail political risks for the Fed. We would likely be selling the longer maturity assets in our portfolio at a loss, meaning that we may be unable to make any remittances to the U.S. Treasury for some years. Yet, if we don’t tighten quickly enough, we could find ourselves far behind the curve in restraining inflation.     
While these risks are very hard to quantify, it is clear that the larger the Fed’s portfolio becomes, the higher the risk and the potential costs when it comes time to exit. And based on my economic outlook, that time may come well before mid-2015. In my view, to keep the funds rate at zero that long would risk destabilizing inflation expectations and lead to an unwanted increase in inflation.
Wow, two Fed presidents hinting that the Fed's endgame will end badly! If only Bernanke would come around...

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