Philadelphia Federal Reserve Bank President Charles Plosser said Tuesday it would be “dangerous” to leave interest rates unchanged at a historically low level if the jobless rate falls near 5% and the inflation rate is near the Fed’s target of 2%.
“I believe that having a real interest rate at zero when the funds rate is at 2% and when inflation is at target and unemployment is close to 5% is a dangerous place for monetary policy to be,” he told reporters after a speech to a conference on financial regulation.
Explaining his earlier remarks that the Fed funds rate should be at 3% by the end of 2015 and 4% a year later, Plosser emphasized his opposition to some other members of the Federal Open Market Committee.
“In 2016, if we are somewhere in the low 5s on unemployment rate, and if inflation is at 1.8 or 1.9% which is what I think is there, by almost anybody’s definition, that is pretty close to full employment, and our inflation target,” he said.
“Lots of people on the committee believe that we can stay at those goals and still have a funds rate that’s at 2%,” he said.
He said he was puzzled by the International Monetary Fund’s warning Tuesday that the Fed should avoid what it called a “premature withdrawal of monetary accommodation,” given the ongoing monthly bond purchases.
“I don’t think we are even close to withdrawing support prematurely,” he said. “Even if we were to stop buying assets altogether, interest rates would be at historic record lows.”
“It doesn’t sound to me like a central bank that’s intending to withdraw accommodation prematurely,” he said.
And he warned that inflation could return if banks start using the unusual level of liquidity that the Fed has provided to the system through its stimulus program.
“When the banks find it attractive to lend that money out, perhaps with higher interest rates, that’s when we are going to generate a lot of inflation if we wanted to because we would just let that money flow out of the banking system,” Plosser said.
“I find it puzzling that somehow given the degree to which we put accommodation, and are still putting accommodation into the system through our asset purchases, and our signal that we will keep rates well below where they normally would be, it doesn’t sound to me like a central bank that’s intending to withdraw accommodation prematurely.”
Asked about Fed Chair Janet Yellen’s recent statement that the Fed could start to tighten some six months after quantitative easing ends, Plosser noted that she also said any such action would depend on the economic data.
For that reason, the latest Fed statement was a “step in the right direction,” he said.
“It wasn’t as precise or as clear as I might have liked but by taking a step back away from thresholds, we made it very clear that our policy was dependent on how the data evolved,” he said.
“That suggests to me that progress toward our goals means as we get closer to what we think of as our objectives – which primarily are 2% inflation and some notion of a well functioning labor market, policy ought to be thinking about moving in the other direction rather than trying to get looser.
“So it’s pretty clear I think that that language suggests the direction the committee wants to move as changes are made toward our goal.”