Atlanta's Dennis Lockhart Joins Doves Begging For QE2
On the wires:
- Fed's Lockhart says leaning in favour of more monetary stimulus, decision not clear cut
Somehow this will lead to even more QE "pricing in", even though by now it is "priced in" about 150%. Of course, this is no surprise as Lockhart has long been in the opposing camp of an ever increasing group of hawkish Fed presidents such as Hoenig, Bullard, Kocherlakota and to some extent, Fisher. That only one of them is a voting member is irrelevant. After all at the end of the day, only one madman has the launch codes.
Some more Lockhart quotes:
- may back Fed purchases to head off deflation
- sees further easing as insurance against risk of disinflation turning into deflation
- favours adopting more explicit inflation objective, would strengthen effects of easing and mitigate risks
- speculation about Fed easing has contributed to concern over competitive devaluations
- inflation has settled at level considered by many to be unacceptably low
- sluggish growth, inflation, creates possibility of a deflationary situation
- inflation rate of about 2% constitutes price stability 'in my view'
- sees growth picking up modestly from Q2 rate, but with downside risks
- sees scope for monetary policy to spur spending by consumers and businesses
Highlights from his speech at the Savannah Rotary Club:
- Lockhart sees the prospect of continued slow but gradually accelerating economic growth, with quite low but stable inflation and a positive but frustrating pace of job creation. He believes that the possibility of deflation cannot be completely dismissed, although deflation is by no means his base case expectation.
- Lockhart thinks that there is scope, at the margin, for further monetary stimulus to boost demand growth and reduce unemployment. Therefore, he is sympathetic to more monetary stimulus in the near future and views additional quantitative easing as a form of risk management. He will factor in the deliberations of the FOMC before arriving at a final view.
- Lockhart is open to the adoption of a more explicit inflation objective as a further step to ensure the anchoring of public expectations about long-term inflation and the response of the FOMC to adverse price developments.
avannah is a city where insiders use the shorthand of initials—MGGE (Midnight in the Garden of Good and Evil)
and SCAD (Savannah College of Art and Design). Today I will talk about
an economic policy issue that, similarly, has been reduced to shorthand:
QE2. This is not the famous luxury ocean liner; QE stands for
quantitative easing, and the "2" denotes a second round of this policy
activity. QE2 is a policy option currently under consideration to
support the sputtering economic recovery and deal with two of its
by-products: high unemployment and low inflation that could spill over
This policy option is the issue of the moment among Fed watchers.
Commentators and market participants appear to have a high expectation
that the Federal Open Market Committee (FOMC) will decide to go forward
with another program of large-scale asset purchases (LSAP—another set of
initials used officially in the recent past). The Fed used this policy
tool starting at the end of 2008 until spring of 2010 when it purchased
$1.25 trillion of mortgage-backed securities, $300 billion of Treasury
securities and $175 billion of agency debt securities, creating fresh
money in the process to make the purchases. These actions were taken to
combat the recession at a point when there was no more scope for use of
the Fed's more conventional policy tool, interest rate policy. The
policy rate still remains at its zero lower bound and, for all practical
purposes, cannot go lower. If something is to be done about the state
of the economy, quantitative easing is the leading option.
To opt for more quantitative easing at this juncture is a big
decision. Today I will walk you through the thicket of considerations
that lead me, at this moment, to be sympathetic to more monetary
stimulus in the near future. I take this view with a measure of
tentativeness. Some more economic data will be posted before the next
meetings of the FOMC in early November and mid December, and, as I
always do, I would factor in the deliberations of the committee in the
meeting before arriving at a final view.
I must emphasize that the views I will express are my personal
thoughts and may not reflect the views of my colleagues on the FOMC or
within the Federal Reserve.
State of the economy
The recent performance of the economy has been disappointing. Growth
has slowed from earlier in the year and unemployment remains high. After
a period of disinflation last year and early this year, inflation has
settled at a level considered by many to be unacceptably low.
This experience is worse than many had forecast. Over the past few
months, a number of forecasters have written down their projections for
the remainder of 2010 and 2011. A year ago, looking ahead to 2010 and
2011, our forecast at the Federal Reserve Bank of Atlanta was less
optimistic than those of many forecasters, so we have not revised down
our outlook all that much. But overall it's fair to say the consensus
outlook has deteriorated.
The Fed is mandated by Congress to pursue two policy goals—maximum
possible employment and price stability (or put differently, the
acceptable rate of inflation). The committee has the implicit
responsibility of defining the rate of inflation that over the longer
term constitutes price stability. In my view, that rate is around 2
With current inflation running at about 1 percent or a little higher
and with official unemployment measured at 9.6 percent, it's clear that
the economy is not where we want it to be. In my mind, the question is
whether this situation is a call to immediate action.
To answer that question, I start with the outlook from today in the
absence of further monetary stimulus. As a starting point, I expect
final measures of third quarter GDP growth to be close to that in the
second quarter which came in at 1.6 percent. My current forecast sees a
modest increase in the rate of growth in the fourth quarter and further,
but still modest, improvement in 2011. In this forecast, inflation
remains low but with no further disinflation, and unemployment comes
down very gradually.
In my thinking, the range of plausible divergence from this forecast
is quite wide, and the risks are more to the downside. Very
importantly—and this is a key point for me—the fact that growth is so
sluggish and inflation so near zero presents the possibility of a
deflationary situation developing, with very serious implications for
employment. We want to avoid deflationary territory. Deflation can feed
on itself, turning into a deflationary spiral. This possibility is by no
means my base case expectation, but I don't think it can be blithely
dismissed. For now it is a risk, not an actual developing feature of the
So, again, my staff and I see the prospect of continued slow but
gradually improving growth, with quite low but stable inflation and a
positive but frustrating pace of job creation. We have to ask: Is this
the best we can achieve?
Structural or cyclical?
Well, it's debatable, and it revolves around the question of
whether the underlying problems of the economy—the obstacles to faster
recovery—are mostly structural or mostly cyclical. These words can mean
different things to different people and represent code words for an
array of conditions. I think of structural obstacles as very slow and
resistant to change and not responsive in the short term to monetary
stimulus. I use the term cyclical to encompass aspects of the economy
that are evolving on a shorter timeline that can be accelerated by
There are a number of features of the current economic situation that
might be described as structural. Certain industries—homebuilding, for
example—are likely to operate at a much lower unit volume for a long
time, if not permanently. Well-informed opinion holds that the
commercial real estate sector will take several years to work through
the burden of property loan resolution. And the central debate focuses
on the degree to which unemployment reflects structural impediments.
In my opinion, the evidence either way is not conclusive. My best
assessment is some unemployment is structural in nature and some of it
represents weak demand. That so-called natural rate of unemployment is
probably now well above the very low level of joblessness we saw prior
to the recession, but it is not the current rate of 9.6 percent. There
is some labor resource slack that can be worked off with improved
consumer demand and business investment. But there is little scope for
monetary policy to have much effect on the mismatch between skills and
jobs caused by industrial dislocations and the skill erosion that can be
associated with long-term unemployment.
Although not usually classified as a structural issue, uncertainty is
a key factor constraining job growth and investment. I hear this
refrain often from business contacts about the current environment. They
cite the future of the economy itself as well as uncertainty related to
employee health care cost, regulatory uncertainty, and fiscal and tax
uncertainty. My contacts frequently make the point that much of this
uncertainty cannot be dispelled by monetary policy.
I do believe there is scope, at the margin, for further monetary
stimulus to induce households and businesses to overcome their current
spending caution, even while deleveraging. A quantitative easing program
of scale should have the effect of making credit cheaper and, if
successful in upgrading the outlook, more available as loan demand
This comment on the potential and effect of lower interest rates
raises a question: Through which channels or mechanisms would additional
stimulus have its intended positive effect on the economy? There are a
number of possible channels of influence. The credit channel is
certainly one. Skeptics, however, point out that there is no lack of
liquidity in the banking system. Today the Federal Reserve holds over
$960 billion of excess reserves of banks on its balance sheet. This
money is part of the monetary base but has not yet been transformed into
broad stimulus in the real economy through bank lending.
A second possible channel is called the portfolio balance effect. If
the Fed buys a significant portion of available Treasury securities, for
instance, investors may feel the need to migrate their holdings to
other assets that carry more risk, such as corporate bonds and equities.
The buying pressure in these asset classes could push up values and
generally improve the atmosphere that supports risk taking and spending.
A third channel is the dollar exchange rate and stimulus to net
exports. Speculation about QE2 has already caused a drop in the dollar's
value on exchange markets and contributed to the rising concern over
competitive efforts among nations to influence the relative position of
currencies. Sellers of the dollar are responding to the prospect of
Pros and cons of QE2
In this walk-through of considerations, pro and con, on the QE2 policy
question before Fed policymakers, I could be accused of playing Hamlet.
To cut through it all, let me summarize the case for and the case
against, and then I'll express my personal opinion.
Proponents of QE2 might argue that not all the headwinds the economy
faces are structural in nature and that further stimulus will raise
demand. Purchases of Treasury securities will lower long-term interest
rates (some of this effect on rates may already have been priced into
the yield curve), and lower rates will generate some additional purchase
and investment activity. And, yes, the portfolio balance effect and the
export effect will raise the economy's boats. Taking a defensive
perspective, proponents of QE2 argue that the risk of deflation is not
negligible and this potentiality must be forestalled. Furthermore,
patience with the high level of joblessness and underemployment runs the
risk of weakening the fabric of the country if long-term unemployment
erodes skills and creates a permanent class of unemployed. Finally,
proponents may argue that the risks associated with an even larger
Federal Reserve balance sheet—the challenge of a policy exit or
unwinding as the economy improves—are acceptable. The exit tools are
well advanced and scalable. So this is the case in favor.
The case against QE2 at this time goes like this: Further monetary
stimulus will have limited effect. The financial system already has
plenty of liquidity. Interest rates are very low, and lower mortgage
rates, for example, won't generate a lot of new home buying given
eligibility requirements. Further, the problems besetting the economy
are not fundamentally amenable to a monetary policy solution. They will
take time and depend more on getting clarity on the country's long-term
fiscal path, taxes, and regulatory impact on businesses. Skeptics also
argue that the Fed, by further expanding its balance sheet, incurs exit
risk that could dislodge inflation expectations and lead to an unstable
inflation situation. Finally, critics of this policy direction may argue
that QE2 amounts to monetization of federal debt in another year of
deficits exceeding $1 trillion. Accusations of monetization could
undermine confidence in the dollar and American monetary policy with
substantial long-term costs.
In my view, the decision is not clear cut. We policymakers have to
weigh these arguments pro and con, potential costs versus benefits, and
competing risks. As I said earlier, I am leaning in favor of additional
monetary stimulus while acknowledging the longer-term risks the policy
may present. At this juncture, and given the circumstances of sluggish
growth and measured inflation that is too low, I give greater weight to
the risk of further disinflation leading to deflation. In my mind, QE2
is a form of risk management—an insurance policy that is prudent to put
in place at this time.
More explicit inflation objective
I am also open to a move that I believe would strengthen the
effect and compensate for potential risks of the policy action—that move
is the adoption of a more explicit inflation objective by the
committee. I believe doing so might serve as a further step to ensure
the anchoring of public expectations about long-term inflation and the
response of the FOMC to adverse price developments. I consider a more
explicit inflation target as something the public could easily
understand, and I believe it would reduce uncertainty at a time when it
is badly needed.
You here in Savannah—one of the country's leading port cities—will
understand the metaphor of navigating shoals. The economic challenges of
the moment call for careful navigation. There are risks accompanying
both action and inaction, but the risks that weigh more heavily on my
mind are those associated with a movement toward deflation. I am
prepared to consider action in the near term that can help avoid that
danger and change the course of the economy for the better.