Bernanke, Philadelphia Fed’s Plosser differ publicly on new policy
Key fault lines are emerging at the Federal Reserve over the central bank’s journey into uncharted monetary policy.
In a speech on Tuesday, Philadelphia Fed Bank president Charles Plosser publicly took issue with positions advocated by Fed chief Ben Bernanke.
The Fed has begun purchasing commercial paper, mortgage-backed securities, and other assets to keep the markets from collapsing.
Bernanke signaled on Monday that it was full speed ahead with these new purchases. See full story.
He even talked about an expansion of the plan – saying the Fed’s plan to purchase consumer and small business loans with the help of the Treasury was a model “that can be expanded to accommodate higher volumes or additional classes of securities as circumstances warrant.
He said he sees no near-term problem with inflation.
On the other hand, Plosser urged the Fed to “proceed with caution” with the new policy. Others outside the Fed are much more strident and want plans in place immediately to reverse it. They believe an inflation storm is already in train.
“It is a huge disagreement,” said Robert Brusca, chief economist at FAO Economics.
While the Fed chairman has made it a practice to run a more democratic central bank, the disagreements come at a crucial time when the Fed is striving to appear on top of the current financial market crisis and steep recession.
Bernanke argued that focusing on the size of the balance sheet misses the point, arguing the Fed’s various asset purchase programs are not easily summarized in a single number.
But Plosser said that the growth of the Fed’s balance sheet was a key metric.
“It is not appropriate to ignore quantitative metrics in this new policy environment,” Plosser said.
On the surface, the debate is about how the describe the programs.
Bernanke and Fed officials have gone to great lengths to say that the new policy is not “quantitative easing” similar to the Bank of Japan’s actions in the 1990s.
Instead, Bernanke called the new program “credit easing” and tried to put the focus on “the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses.”
But Plosser is bringing the spotlight right back to the Fed’s balance sheet.
“The size of the balance sheet does offer a possible nominal anchor for monitoring the volume of our liquidity provisions,” Plosser said.
Underneath the surface is a real concern about how and when the Fed tries to exit from its new monetary policy.
Fed officials who pay attention to the money supply believe that the Fed’s current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late.
Bernanke’s remarks indicate he wants the flexibility and doesn’t want to tie his hands.
William Poole, who recently left his post as president of the St. Louis Fed, says it is crucial that the Fed set a target for cutting its balance sheet.
Poole said the expansion of the Fed’s balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow.
“I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes,” Poole said in an interview.
“I believe that the Fed should set a hard number – a target that they take seriously for the overall size of the balance sheet,” he said.
Plosser also argued that the Fed has put its independence at risk by buying long-term assets. He worried that some “interest groups” will try to use political persuasion to stop the Fed from selling these longer-term assets even if the central bank has decided it makes sense.
“We will need to have the political fortitude to make some difficult decisions about when our policies must be reversed or unwound,” Plosser said.
Bernanke said that he would watch this situation closely but didn’t expect it to be a “significant problem.”
Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.
The light at the end of the tunnel is no where to be seen. When will this madness end?