Philadelphia Federal Reserve Bank President Charles Plosser Wednesday argued that there are grounds for the central bank to wind down its asset purchase program at a faster rate than the current measured pace, citing the strengthening economy and rapid decline in unemployment.
“A case can be made for ending the current asset purchase program sooner to reflect the improvement in the economic outlook and to lessen some of the communications problems we will face with our forward guidance,” Plosser said in remarks prepared for delivery at a conference of local business leaders in Rochester, New York.
“I believe the economy has already met the criteria of substantial improvement in labor market conditions, and the economic outlook has improved as well. So my preference would be that we conclude the purchases sooner rather than later,” he added.
The policymaking Federal Open Market Committee decided last week to scale back its monthly bond purchases by $10 billion to $65 billion a month. Plosser is a voter on the FOMC this year.
Plosser said the argument for speeding up the pace of the FOMC’s taper is supported if the economic outlook plays out as he expects, noting that if the unemployment rate continues to drop at its current pace, it will soon reach the 6.5% threshold in the FOMC’s forward guidance for interest rates.
“I would like to see purchases concluded before the unemployment rate reaches the threshold, which is likely during the first half of the year,” Plosser said.
“Although the FOMC has indicated that it doesn’t anticipate raising rates when the economy crosses that threshold, I do believe that we will have complicated our communications if we are still purchasing assets at that point,” he cautioned. “What is the argument for continuing to increase monetary policy accommodation when labor market conditions are improving rapidly, inflation has stabilized, and the outlook is for it to move back to goal?”
Plosser warned that the longer the Fed continues its asset purchases in such an environment, the more likely it is that the central bank will “fall behind the curve” in withdrawing the record amounts of monetary stimulus it has provided.
“With the economy awash in reserves, the costs of such a misfire could be considerably higher than usual, fomenting higher inflation and perhaps financial instability,” he said.
Emerging market currencies have been roiled since the Fed first indicated it would begin reducing the pace of its asset purchases, with countries such as India, Indonesia and Turkey particularly affected in recent weeks.
Plosser said the current volatility in emerging market currencies could pose a risk if it were to spill over more broadly to other financial markets, but that “at this point, I do not consider it a significant risk to the U.S. economy.”
In fact, he said that although there remain some downside risks to growth, “for the first time in a few years, I see a potential for some upside risks to the economic outlook. We need to consider this possibility as we calibrate monetary policy.”
Plosser noted that monetary policy will still be highly accommodative even after the FOMC ends the asset purchase program. “As the expansion gains traction, the challenge will be to reduce accommodation and normalize policy in a way that ensures that inflation remains close to our target, that the economy continues to grow, and that we avoid sowing the seeds of another financial crisis,” he said.
Plosser provided a somewhat bullish outlook for the economy in 2014, noting that it is on “firmer footing” compared to the past several years given that there is less fiscal drag and the housing recovery continues.
“Although growth in the first quarter is likely to be somewhat slower than the rapid pace we saw in the fourth quarter of last year, overall, I anticipate economic growth of around 3% this year,” he said, “this is far from the robust growth that many would like to see; nevertheless, it does represent steady progress and an improving economy.”
This rate of growth will mean continued declines in the unemployment rate to about 6.2% by the end of 2014, he added.
The labor market has performed “noticeably better” than expected, he said, pointing to the fall in the jobless rate in December to 6.7%.
Many have taken issue with this rapid fall in unemployment, with Plosser noting there is some concern that the unemployment rate will shoot back up when discouraged workers reenter the labor force. “Based on research by my staff, I am less concerned about this possibility,” he countered.
Some Fed officials have advocated using a broad range of indicators to gauge the health of the jobs market, but Plosser said he believes the overall unemployment rate “remains the best summary statistic of labor market conditions.”
As for the other arm of the Fed’s dual mandate, price stability, Plosser stressed the importance of defending the FOMC’s 2% inflation target “from both below and above.”
“But I believe inflation is likely to firm up,” he said, as “economic growth is accelerating, and some of the factors that have held inflation down, such as the one-time cut in payments to Medicare providers, are likely to abate over time.”
So he shares the FOMC’s expectation – voiced in its Jan. 29 statement – that inflation will move back toward the target over time. “Indeed, given the large amount of monetary accommodation we have added and continue to add to the economy, I think there is some upside risk to inflation in the longer term,” Plosser warned.