It was dove vs hawk on Thursday as two Fed district presidents — James Bullard of St Louis and Charles Plosser of Philadelphia, respectively — gave separate speeches sharing their views on the efficacy of QE2 and the economy.
Bullard loses his vote next year, while Plosser gains one — which is representative of the overall hawkish shift taking place on the committee next year, even if these two are at extreme ends of the dove-hawk spectrum.
Plosser essentially reiterated his previous concerns about the Fed’s exit strategy from QE2 and remained unconcerned that deflation was a real threat. He was also skeptical that monetary policy could do any more to help the employment situation.
His conclusion, with our emphasis:
The November FOMC statement indicated that we will regularly review the purchase program in light of incoming economic information and adjusting it as needed to foster our long-run goals of price stability and maximum sustainable employment. I take this intention to regularly review the program seriously, and I will be looking for evidence of the hoped-for benefits as I evaluate the program before each meeting. If we do not see these benefits, I would not infer that we merely need to increase the size of the program. Rather, I would take this as evidence that we need to rethink the analysis of costs and benefits that led us to this policy in the first place. If the economy grows more quickly than I currently anticipate, the purchase program will need to be reconsidered and perhaps curtailed before the full $600 billion in purchases is completed. On the other hand, if serious risks of deflation or deflationary expectations emerge, then we would need to consider whether expanded asset purchases should be used to address these risks. However, we would then need to clearly communicate that we were taking this step to combat deflation and deflationary expectations, and not as an action to speed up the recovery.
Bullard, meanwhile, in a long presentation stressed the disinflationary trend that had taken hold in 2010, but the really interesting bit was his use of graphs to show that QE2 is working as it should. Using his headlines:
Real interest rates declined
Expected inflation increased
The dollar depreciated
Equity prices increased
You can see that nearly all of the indicators actually started heading in the opposite of their intended direction after the size of QE2 was announced by the FOMC.
Bullard is making the case that the Fed’s earlier signal (at Jackson Hole) that it would pursue some kind of easing was enough to shift the markets in the direction it wanted. That these markets then experienced a correction after November 3 was the natural response to an overbought trade.
And to Bullard and the other supporters, it doesn’t matter that treasury yields seem to be untethered from the Fed’s actions — what matters (especially at the zero lower bound) are expected long-term real interest rates. And thanks to increasing inflation expectations, those have declined.
He may have a point, though FT Alphaville continues to be a complete agnostic on QE2. No, we don’t think runaway inflation will be an issue, but the potential for distorted asset markets and unintended consequences simply make it too early for us to know if it’s a good idea.
When strange things happen at the zero lower bound – FT Alphaville
FOMC composition and future monetary policy – FT Alphaville
Inflation as (un)expected – FT Alphaville