Philly Fed's Plosser hints that there is a lively internal debate going on within the Federal Reserve about its proper role

Philadelphia Fed President Charles Plosser speaking before the Central Bank of Chile on "The Scope and Responsibilities of Monetary Policy" Plosser calls for limits to what is expected from the Fed.  He says that policy focus should rest on maintaining a low, stable inflation environment as it key objective to bolster the economy.  This is better than printing money for jobs, but we here think interest rates are still way too low.   In this he is tacitly admitting that low rates and quantitative easing do not create jobs. 

He states that the Fed should be limited to using only short-term Treasuries when conducting monetary policy transactions. He also makes the important point that monetary policy is a blunt instrument and should not be used to preclude assets bubbles in specific classes of investments, nor should monetary policy be expected to reduce unemployment outside of what would be produced in a favorable, low inflation environment. Finally, Plosser calls for a return to a clear distinction between monetary and fiscal policy.

While today's comments reflect no updates on immediate monetary policy or the status of the economy, they clearly indicate there is a strong debate going on inside the Fed on its proper role.  Via Philly Fed:

"The U.S. Congress has established the broad objectives for monetary policy as promoting "effectively the goals of maximum employment, stable prices and moderate long-term interest rates." This has typically been characterized as the "dual mandate," since if prices are stable and the economy is operating at full employment, long-term nominal interest rates will generally be moderate.

"Most economists now understand that in the long run, monetary policy determines only the level of prices and not the unemployment rate or other real variables. In this sense, it is monetary policy that has ultimate responsibility for the purchasing power of a nation's fiat currency. Employment depends on many other more important factors, such as demographics, productivity, tax policy, and labor laws. Nevertheless, monetary policy can sometimes temporarily stimulate real economic activity in the short run, albeit with considerable uncertainty as to the timing and magnitude, what economists call the "long and variable lag." Any boost to the real economy from stimulative monetary policy will eventually fade away as prices rise and the purchasing power of money erodes in response to the policy. Even the temporary benefit can be mitigated, or completely negated, if inflation expectations rise in reaction to the monetary accommodation.

"Let me be clear that this does not mean that monetary policy should be unresponsive to changes in broad economic conditions. Monetary policymakers should set their policy instrument - the federal funds rate in the U.S. - consistent with controlling inflation over the intermediate term. So the target federal funds rate will vary with economic conditions. But the goal in changing the funds rate target is to maintain low and stable inflation. This will foster the conditions that enable households and businesses to make the necessary adjustments to return the economy to its sustainable growth path. Monetary policy itself does not determine this path, nor should it attempt to do so.

"Therefore, in most cases the effects of shocks to the economy simply have to play out over time as markets adjust to a new equilibrium. Monetary policy is likely to have little ability to hasten that adjustment. In fact, policy actions could actually make things worse over time. For example, monetary policy cannot retrain a workforce or help reallocate jobs to lower unemployment. It cannot help keep gasoline prices at low levels when the price of crude oil rises to high levels. And monetary policy cannot reverse the sharp decline in house prices when the economy has significantly over-invested in housing. In all of these cases, monetary policy cannot eliminate the need for households or businesses to make the necessary real adjustments when such shocks occur.

"Another challenge in addressing asset-price bubbles is that contrary to most of the models used to justify intervention, there are many assets, not just one. And these assets have different characteristics. For example, equities are very different from real estate. Misalignments or bubble-like behavior may appear in one asset class and not others and may vary even among a specific asset class. But monetary policy is a blunt instrument. How would policymakers have gone about pricking a bubble in technology stocks in 1998 and 1999 without wreaking havoc on investments in other asset classes? After all, while the NASDAQ grew at an annual rate of 81 percent in 1999, the NYSE composite index grew just 11 percent. What damage would have been done to other stocks and other asset classes had monetary policy aggressively raised rates to dampen the tech boom. During the housing boom, some parts of the U.S. housing market were experiencing rapid price appreciation while others were not. How do you use monetary policy to burst a bubble in Las Vegas real estate, where house prices were appreciating at a 45 percent annual rate by the end of 2004, without damaging the Detroit market, where prices were increasing at less than a 3 percent annual rate?

"I have long argued for a clear bright line to restore the boundaries between monetary and fiscal policy, leaving the latter to Congress and not the central bank. For example, I have advocated the elimination of Section 13(3) of the Federal Reserve Act, which allowed the Fed to lend directly to "corporations, partnerships and individuals" under “unusual and exigent circumstances.” The Dodd-Frank Wall Street Reform and Consumer Protection Act sets limits on the Fed’s use of Section 13(3), allowing the Board, in consultation with the Treasury, to provide liquidity to the financial system, but not to aid a failing financial firm or company. But I think more is needed. I have suggested that the System Open Market Account (SOMA) portfolio, which is used to implement monetary policy in the U.S., be restricted to short-term U.S. government securities. Before the financial crisis, U.S. Treasury securities constituted 91 percent of the Fed’s balance-sheet assets. Given that the Fed now holds some $1.1 trillion in agency mortgage-backed securities (MBS) and agency debt securities intended to support the housing sector, that number is 42 percent today. The sheer magnitude of the mortgage-related securities demonstrates the degree to which monetary policy has engaged in supporting a particular sector of the economy through its allocation of credit. It also points to the potential challenges the Fed faces as we remove our direct support of the housing sector.

"Decisions to grant subsidies to specific industries or firms must rest with Congress, not the central bank. That is why I have advocated that the Fed and Treasury reach an agreement whereby the Treasury exchanges Treasury securities with the non-Treasury assets on the Fed's balance sheet. This would transfer funding for the credit programs to the Treasury, thereby ensuring that policies that place taxpayer funds at risk are under the oversight of the fiscal authority, where they belong. And it would help ensure that monetary policy remains independent from fiscal policy and political pressure.

"Although it has been over 40 years since Milton Friedman cautioned against asking too much of monetary policy, his insights remain particularly relevant today. I too am concerned that we are in the process of assigning to monetary policy goals that it cannot hope to achieve. Monetary policy is not going to be able to speed up the adjustments in labor markets or prevent asset bubbles, and attempts to do so may create more instability, not less. Nor should monetary policy be asked to perform credit allocation in support of particular sectors or firms. Expecting too much of monetary policy will undermine its ability to achieve the one thing that it is well-designed to do: ensuring long-term price stability. It is by achieving this goal that monetary policy is best able to support full employment and sustainable growth over the longer term, which benefits all in society."


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