June 6 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said a plan to withdraw the central bank’s record monetary stimulus and “normalize” interest-rate policy would help avert confusion in financial markets.
“By articulating a systematic plan that gets us to our objective, we improve communication with the public, reduce uncertainty in the marketplace and lend credibility to the commitment that policy makers will follow through,” Plosser said today in Helsinki in the prepared text of a speech.
Chairman Ben S. Bernanke and the Federal Open Market Committee, which includes Plosser, are considering the tools they would use to pull back stimulus, according to the minutes of their April meeting. One possible sequence is to end the policy of reinvesting proceeds from maturing securities and later raise interest rates and sell assets, though such moves “would not necessarily begin soon,” according to the minutes.
“Perhaps more important than the details of any exit plan is the very establishment of a systematic plan itself -- one that can be clearly communicated to the markets and the public in a way that reduces uncertainty,” Plosser said. “There is no one right plan to achieve this outcome.”
The central bank needs a plan that restores the target interest rate as the “primary instrument” of monetary policy, shrinks the Fed’s balance sheet to a level “much smaller, probably less than $1 trillion” and returns the composition of the balance sheet to predominantly shorter-term Treasury securities, he said.
Expanding Balance Sheet
The central bank’s balance sheet has swelled to $2.79 trillion from $924 billion the week before the bankruptcy of Lehman Brothers Holdings Inc. in September 2008. As of June 2, the Fed’s assets include $918 billion in mortgage-backed securities, $119 billion of federal agency debt and $64 billion of assets purchased in the bailouts of Bear Stearns Cos. and American International Group Inc.
Plosser outlined two plans for reducing the balance sheet. The Fed could quicken the pace of sales while raising the federal funds rate. Or the pace of sales would remain constant and the central bank would use the interest rate to respond to changing economic conditions.
“The temptation to manipulate the pace of sales based on some unspecified criteria might arise,” Plosser said. “Indeed, the major thrust of either plan is to avoid just such a temptation. A good plan will provide clear, reliable guidance on how asset sales will proceed and the conditions under which they may or may not change.”
Plosser repeated his call for the central bank to commit to an explicit target for the rate of inflation. He did not state his preference for when the central bank should begin selling assets or raising interest rates in his remarks.
Plosser, 62, voted to complete the central bank’s $600 billion of bond purchases and backed its decision to keep interest rates “exceptionally low” for an “extended period.” In 2008, he dissented twice in favor of less monetary stimulus.
--Editors: James Tyson, Brendan Murray
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