Is it time to steer QE2 back to the dock? One regional Fed president says it is time to ponder.
Jeffrey Lacker, the president of the Federal Reserve Bank of Richmond and an alternate member of the Federal Open Market committee, said in a speech Tuesday that improving economic numbers suggest it is time to “quite seriously” re-evaluate the need for continued quantitative easing, or large-scale Fed purchases of Treasury bonds.
The Committee recognized that the provision of further monetary stimulus at this point in the business cycle is not without risks, and therefore committed to regularly review the pace and overall size of the asset-purchase program in light of incoming information and adjust the program as needed. The distinct improvement in the economic outlook since the program was initiated suggests taking that re-evaluation quite seriously. That re-evaluation will be challenging, because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend.
Without necessarily sounding the alarm on inflation, Lacker – long known as one of the more hawkish regional Fed officials, along with Dick Fisher of Dallas and Charles Plosser of Philadelphia – said it is worth keeping an eye on rising food and fuel prices. His comments say he doesn’t buy the output gap argument that inflation doves are making, to the effect that inflation won’t take root until a stronger recovery takes the slack out of the system.
Many forecasters are expecting inflation this year to come in between 1-½ and 2 percent. That is my expectation as well, and would represent a good outcome. Still, recent increases in commodity prices are showing up in consumer price measures and will put upward pressure on overall inflation numbers in the months ahead. Just how much is hard to say. The effect on overall inflation could be transitory, or could persist if firms, encouraged by accelerating demand growth, pass input prices on to their customers.
Even so, he concedes that warning signs such as the standard market measures of inflation expectations (see chart, right) aren’t yet flashing red.
Such pickups in inflation are common at this point in business cycle upturns, and would be consistent with the expected inflation rates implied by prices of inflation-indexed U.S. Treasury debt, which show market participants now expecting inflation to average 2 percent over the next five years, and as much as 3 percent over the following five years.
The inflation warnings aside, it is clear that like Fed chief Ben Bernanke, Lacker is exercised about the deteriorating U.S. fiscal picture. He warns that a U.S. funding crisis is inevitable if Congress and the White House don’t start acting responsibly, and soon.
Be clear: there is no uncertainty about whether the long-run federal budget imbalance will be corrected. Continual increases in debt relative to the size of our economy are simply not feasible and will not happen. The real question is how a sustainable path will be achieved. In advance, by deliberately adopting and following a credible strategy, or in extremis, forced by investor retreat and collapsing market confidence to adopt drastic emergency measures? We would be wise to heed the abundant empirical evidence of the superiority of taking action before a fiscal crisis is upon us.
Wisdom hasn’t been a hallmark of U.S. policy on practically any front lately, but Lacker says he will keep his fingers crossed.
We’ve come through an extraordinary period in our economic history, which in turn brought about extraordinary policy responses. As the economic expansion continues to strengthen, the challenge becomes determining the time and manner by which policy returns to a more normal mode of behavior. The public’s confidence that policy actions derive from a coherent, sustainable long-term plan for policy – both monetary and fiscal – will be an important factor supporting growth in the years to come. I am hoping that we will see steady progress in 2011.