Two Fed Officials Speak on Support for Fed Policy, Describe Exit Plans

We had two speeches Tuesday by two voting members of the policy-setting committee of the Federal Reserve, the Federal Open Market Committee (FOMC). These include James Bullard, President of the St. Louis Fed, and William Dudley, President of the New York Fed and Vice Chairman of the Federal Reserve. Dudley is one of the more senior members of the Fed, given that he is Vice Chairman and that, as President of the New York Fed, he has a permanent vote on the committee. He wouldn't say explicitly whether he views the Fed should taper its bond purchases sooner than later, instead saying: “In terms of our asset purchase program, I believe we should be prepared to adjust the total amount of purchases to that needed to deliver a substantial improvement in the labor market outlook in the context of price stability. In doing this, we might adjust the pace of purchases up or down as the labor market and inflation outlook changes in a material way. For me, the base case forecast is not the sole consideration—how confident we are about that outcome is also important. “Because the outlook is uncertain, I cannot be sure which way—up or down—the next change will be. But at some point, I expect to see sufficient evidence to make me more confident about the prospect for substantial improvement in the labor market outlook. At that time, in my view, it will be appropriate to reduce the pace at which we are adding accommodation through asset purchases. Over the coming months, how well the economy fights its way through the significant fiscal drag currently in force will be an important aspect of this judgment.” He then spends considerable attention to detailing the Fed's eventual exit plan, noting that the previously conceived exit plan may be “stale” and need to be rethought. To avoid spooking the markets, he emphasizes that any exit plan should be carefully considered and well communicated before beginning the process, given that markets could “overreact.” He also notes that the sale of some assets, particularly the agency mortgage backed securities (MBS), could disrupt the markets; as such, the Fed may want to avoid selling them in the earlier stages of an exit program – or perhaps not even sell them at all. About the exit program, he says, “More broadly, it may be desirable to update our thinking around the path and composition of the balance sheet over time, in light of our capacity to shape this path in a way that mitigates potential costs and risks.” He emphasized the importance of properly communicating the Fed's moves to the markets, given how that market overreaction could “threaten financial stability” and complicate the Fed's “calibration” of monetary policy. Bullard, meanwhile, said that, based on his review of policy options, quantitative easing is and has been the most reliable tool while policy rates have been near zero. Thus, for near-term stabilization policy, Bullard's conclusion for the U.S. is to "continue with the present quantitative easing program, adjusting the rate of purchases appropriately in view of incoming data on both real economic performance and inflation." Another approach that Bullard discussed is for the Fed to maintain low rates but refrain from further action, but ultimately, that would not be the right approach. Bullard said that one might argue that the near-zero policy rate provides sufficient monetary accommodation to keep inflation near target and assist the real economy to the extent possible. However, "The experience from Japan seems to indicate that merely keeping the policy rate near zero for an extended period of time does not by itself keep inflation positive," he said. "In particular, there seems to be a steady state equilibrium in which the nominal rate remains near zero and inflation remains mildly negative." Low rates coupled with higher inflation, near the Fed's two percent target, would represent lower real interest rates than at the current one percent inflation, using the Fed's preferred inflation measure. He also said that forward-guidance, another tool used by the Fed, may give a pessimistic signal. "In general, any attempt to provide additional policy accommodation today by promising easy policy in the future can be viewed as suggesting the future will be characterized by poor macroeconomic performance," he explained. "This can be extremely counter-productive, as firms and households may prepare for a prolonged stagnation."