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Fed's Plosser says Fed needs clear exit strategy
Kristina Cooke
NEWARK, Delaware (Reuters) - The recession could be one of the longest in the post-World War Two era, but the Federal Reserve must articulate a clear exit strategy from its emergency lending programs to ensure economic and financial market stability, a top Fed official said on Wednesday.
Charles Plosser, president of the Philadelphia Federal Reserve Bank, told an economic outlook conference at the University of Delaware that he expects economic growth for 2009 to be well below 2 percent after shrinking in 2008.
"Given that forecast, the current recession could well be one of the longest in the post-World War Two era," he said.
A collapse in the housing market tipped the economy into recession in December 2007 and has fueled the worst financial crisis since the Great Depression.
To support the crisis-stricken credit markets, the Fed has more than doubled its balance sheet to over $2 trillion through measures like buying assets.
"Our aggressive lending, while intended to help the economy and financial crisis recover, poses its own set of challenges," Plosser said. "We must develop a well-articulated exit strategy if we are to maintain control of monetary policy and encourage the revival of strong and disciplined credit markets."
Plosser told reporters after his speech he would prefer the Fed's balance sheet to be "a little more pristine."
Asked during a panel discussion whether the Federal Reserve would buy Treasuries, Plosser said the Fed is discussing buying longer-dated bonds, but has not made a decision yet.
In addition to unconventional policy tools, the Fed has brought down its benchmark overnight funds rate target to between zero and 0.25 percent.
"Without the target funds rate as a nominal anchor, it will be important for us to develop relevant quantitative measures to assess the appropriate size and composition of the Fed's balance sheet," Plosser said.
"We must ensure that our overall balance sheet's size and evolution are consistent with our responsibility to promote price stability. Credit policy alone is not sufficient to ensure sound monetary policy,"
Plosser said that while some of the emergency lending facilities will unwind naturally, some assets like the mortgage and asset-backed securities could stay on the Fed's balance sheet for years.
"Will we face challenges when we attempt to liquidate these longer-term assets from our portfolio? Will there be pressure to extend some of these programs by observers who feel terminating the programs might disrupt fragile markets?" Plosser asked, warning that such pressures could threaten the Federal Reserve's independence.
He said it was important to consider that the central bank's involvement could keep the private sector from returning to credit markets. Also, without clearly stated boundaries to future lending by the central bank, market participants may be inclined to take on more risk in the belief that the Fed will help them if they get into trouble, he said.
Plosser said he did not expect credit spreads to return to narrow pre-crisis levels and that a challenge facing policy-makers as they consider exit strategy is determining what "appropriate" spread levels are.
Despite the length of the recession, Plosser said he does not expect it to be as deep as the one of the early 1980s.
"I do not expect the unemployment rate to stray into double digits during this recession. Yet, I also don't expect it to begin coming down soon," he said.
"I expect the housing sector will finally hit bottom in 2009 and the financial markets will gradually return to some semblance of normalcy," he said. "So my forecast sees the economy starting to slowly recover in the second half of 2009 and building up more momentum in 2010."
Plosser, who was a voting member of the rate-setting Federal Open Market Committee in 2008 and will not be voting again until 2011, said he expects both headline and core inflation to be below 2 percent for the next year.
While he was not particularly concerned about the possibility of persistent deflation, he reiterated his argument for an inflation target.
"Inflation targeting can help central banks signal their commitment to low and stable inflation and thus help prevent expectations from drifting too high or too low," he said.
(Editing by Leslie Adler)
www.reuters.com/article/GCA-Economy/idUSTRE50D48R20090114