A veteran U.S. Federal Reserve official said Thursday the central bank shouldn’t wait long to tighten the stance of monetary policy in order to keep longer-run inflation pressure contained, in what appears to be a recovering economy.
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| Hoenig |
“The process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later,” Federal Reserve Bank of Kansas City President Thomas Hoenig said.
“We cannot afford to be short-sighted,” and “we must more evenly weigh our short-run concerns against the longer-run costs,” the official said. He said the central bank should raise its overnight target rate “to a more normal level, probably between 3.5 and 4.5%, and restore its balance sheet to pre-crisis size and configuration.”
“While I agree that unemployment is unacceptably high and short-term inflation risks are likely small, we must also recognize what monetary policy can and cannot do” in the face of structural shifts in the economy, the policy maker said.
The official, who described himself as holding a “more optimistic” economic outlook than many private-sector economists, warned that keeping rates very low comes with many risks. The Fed’s current overnight target rate is effectively set at zero% and has been at that level for just over a year, amid large scale asset buying that is set to end at the conclusion of the first quarter.
“Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment–not today, perhaps, but in the medium and longer run,” Hoenig warned. He added, “maintaining short-term interest rates near zero could actually impede the recovery process in financial markets.”
Hoenig’s views, which came from the text of speech prepared for delivery before the Central Exchange in Kansas City, Mo., are the most aggressive of any policy maker. They take on added importance because he will hold a voting role on the interest rate-setting Federal Open Market Committee this year. Hoenig’s stance isn’t entirely novel–he gave voice to similar sentiments late last year. Still, they come at a time where policy makers are looking at an improving economy and are weighing what to do with what they all agree is a very stimulative policy stance.
Most economists don’t expect the Fed to change rates until at least mid-2010, if not later. While the buying of mortgage-related securities will end in a few months, some officials are coming to the view the program may need to be kept alive longer, to aid the economic recovery. Policy makers are wrangling with their desire to normalize monetary policy and not kill off a nascent recovery by tightening financial conditions prematurely.
Hoenig noted what lies before the Fed is a “contentious undertaking.” But he also said that “even as the Federal Reserve begins the process of winding down its emergency credit facilities, the extreme amount of policy accommodation means that it will still be some time before monetary policy will return to a more balanced level.”
Hoenig said that monetary policy, along with government stimulus, have both been “instrumental” in engineering a recovery. But much as the Fed will have to tighten relatively soon, so to must the government get its fiscal house in order.
“The ballooning federal deficit must be controlled and reduced,” because if it isn’t, “eventually, there will be pressure put on the Federal Reserve to keep interest rates artificially low as a means of providing the financing,” Hoenig said. And that would be a recipe for hyperinflation, he warned.
The long-serving policy maker was upbeat in his economic views. While “uncertainty remains,” Hoenig said “conditions continue to improve, and we appear to be in the early stages of economic recovery, both in the U.S and internationally.” He added, “economic growth has increased, labor market conditions have begun to stabilize, and housing shows signs of recovery.”
The official reckons the U.S. gross domestic product will likely rise by 3% over the course of 2010. There are “realistic possibilities” stimulus will prove more powerful than now thought, and business could invest more in their activities in the face of a recovering economy, Hoenig said.
But he also said “unemployment will likely remain elevated, and consumers must deal with lower home equity and high debt levels.”
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