N.Y. Fed chief Dudley: 'Further action likely to be warranted'
By Neil Irwin
Bill Dudley, president of the Federal Reserve Bank of New York, gave a speech Friday morning that is a blockbuster, an important read for anyone looking to understand the direction of monetary policy in the months ahead. Given Dudley's degree of influence on the Fed's policy committee -- the New York Fed is the largest and most important of the regional Fed banks, he is vice-chair of the Federal Open Market Committee, and it is his bank that would carry out any new measures to support the economy -- his words carry considerable weight.
It appears that if Dudley gets his way, the Fed will be announcing new measures to ease monetary policy and support the economy, probably at its Nov. 2-3 meeting. "We have tools that can provide additional stimulus at costs that do not appear to be prohibitive," Dudley told the Society of American Business Editors and Writers in New York. "Thus, I conclude that further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long."
That strong inclination to new easing is the headline rocketing around financial markets from Dudley's speech, but there is a lot more packed into the speech that people who follow the Fed and the economy should pay attention to.
Dudley expresses openness to a form of price-level targeting; I cannot recall any other current Fed policymakers having done so, though it has received more wide discussion among economists outside the Fed. This means that if inflation comes in below the Fed's 1.7 to 2 percent unofficial target for a period of time, the central bank would seek to "make up" for it in the form of commensurately above-target inflation afterward. This would help prevent deflation, or falling prices, as investors would be confident that any fall in prices in the near term would be counter-balanced by higher inflation down the road.
"When there is a large amount of slack in the economy, the Federal Reserve might not easily be able to hit an inflation objective soon. But, the central bank could plausibly promise to make up the difference later on. ... To the extent this policy was more credible, it might do a better job keeping inflation expectations from falling. This might make monetary policy more stimulative and, thus, might help the FOMC achieve its objectives more quickly."
He also acknowledges risks to this approach, saying that if people mistakenly believe the Fed was "tinkering with its long-run inflation objective, this could lead to greater uncertainty about future inflation," causing interest rates to rise in a manner that is counterproductive.
Dudley also offered, for the first time publicly, an estimate of how much additional quantitative easing -- or purchases of bonds by the Fed -- would translate into support for the economy. One of the reasons some Fed leaders have been reluctant to undertake a new wave of easing is that the impact is uncertain.
"Some simple calculations based on recent experience suggest that $500 billion of purchases would provide about as much stimulus as a reduction in the federal funds rate of between half a point and three quarters of a point," Dudley said, while noting that the impact depends in part on how long financial markets expect to the Fed to hold the assets.
Dudley notes that the purchases will have the most economic impact if financial markets have confidence that the Fed has the tools and will to sell off the assets when the economy is on more solid footing; if they lack that confidence, inflation expectations could rise, putting upward pressure on long-term interest rates. But he says there's no need to fear. "The FOMC should be able to assure investors that it has both the means and the will to exit when -- but not before - the time is right," Dudley said. "That is because the Federal reserve has the tools to control financial conditions and credit creation even with an expanded balance sheet."
| October 1, 2010; 12:24 PM ET
Categories: Federal Reserve
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