Why the Fed Should Consider Delaying the End of QE
Interest-Rates / Quantitative Easing Oct 16, 2014 - 05:11 PM GMTBy: Bloomberg
James Bullard, President of the St. Louis Federal Reserve Bank, told Bloomberg Television's economics editor Michael McKee today that the Fed should consider delaying the end of QE.
Bullard said, "I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So...continue with QE at a very low level as we have it right now. And then assess our options going forward."
MICHAEL MCKEE, BLOOMBERG NEWS: And we'd like to thank President Bullard for coming in this morning.
And I want to go straight to the question on everybody's mind. You've got global growth concerns. You've got a collapse in inflation expectations, oil prices down and markets extremely volatile now. Is there a role for the Fed? Is there something the Fed should do to address this?
JAMES BULLARD, PRESIDENT, ST. LOUIS FED: Plus the Cardinals lost.
MCKEE: Plus the Cardinals lost. I'm sure that the Fed has a lot of power over that.
BULLARD: U.S. macroeconomic fundamentals remain strong. And I think the U.S. macroeconomic forecast remains intact based on the data that I have today. So I still think we'll get three percent growth in the second half of the year. I still think we'll be over three percent next year.
I also think there are bullish factors coming out of this market selloff that are good for the U.S. economy. Lower long-term rates in the U.S. is usually a bullish factor for the U.S. And lower oil prices is a powerful incentive for the U.S. I think those are feeding into an already strong U.S. economy.
However, I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So -
MCKEE: In other words continue with QE.
BULLARD: Continue with QE at a very low level as we have it right now. And then assess our options going forward. So I think if it was just me on the committee I'm just one person, but if it was just me that's one of the things I'd think about at the October, upcoming October meeting.
MCKEE: Well, you're at $15 billion. You'd keep that level? That wouldn't add very much stimulus to the economy.
BULLARD: No. But it would keep the program alive. And it would keep it, keep the optionality for the committee open as to what we want to do going forward. If the economy is still is as robust as I'm describing it, then I think we could just end the program in December, but if the market is right and it's portending something more serious for the U.S. economy then the committee would have an option of ramping up QE at that point.
So I've been a - I've a long time been one that says that the QE program would be open ended, and that we would be able to adjust it in response to macroeconomic development. This is a serious macroeconomic development. It's primarily coming out of Europe. It's just that Europe was expected to have a good year and they're not. And so growth prospects there are looking bleaker than they were. And the disinflation and even inflation outlook for Europe is not looking good. So this is a development that's occurring in Europe, but it's affecting U.S. markets.
MCKEE: Well, you think the U.S. economy is going to be strong. And so are the markets wrong to be selling off the way they are?
BULLARD: Some of the selloff would make sense and because a lot of U.S. multinationals have important fractions of their business outside the U.S. And so if you thought that the global outlook was worse than previously then it would make sense that some U.S. stocks would be marked down on that basis. So I wouldn't worry about that part. That part seems to make sense.
MCKEE: Now the follow-on would be what do you do about interest rates. You've been in the camp that says you raise rates sooner in 2015, maybe even the first quarter, but are you lower for longer if you want to keep QE going?
BULLARD: Well, as I say I think the forecast for the U.S. based on the data I have today remains intact. I think the tracking forecasts are still strong for the second half of 2014. I've still got three percent or better for 2015. Labor market data has been very good. The last jobs report was very good. Unemployment is down in the five range. We're only a couple jobs reports from being at normal levels of unemployment.
So all of that still looks like it's on track. But I'm willing to acknowledge that this is a serious development in the global situation with the situation in Europe, so that we could invoke our data dependence clause on the taper and at this juncture.
MCKEE: But you would still see a first quarter rate increase if things normalize?
BULLARD: Yes. I mean to get me to change my rate forecast increase you've got to get me to change my forecast. And so as of today I wouldn't change the forecast. If - a lot of people in markets are saying, well, global growth is going to be much weaker and this is going to spill over to the U.S. And so if that kind of a scenario develops and then I would change my forecast, and then hence change my outlook for the first rate increase.
But I don't really see that happening as we sit here today. What I see is a fairly strong U.S. economy that will now be pushed ahead by some bullish factors, lower long-term rates and lower oil prices. And but I think the central bank, the policy committee should be cautious about the decline in inflation expectations, which is a serious matter.
MCKEE: What's causing that? Your forecast, the committee's forecast is for rising inflation to your target.
BULLARD: My forecast is for rising inflation. That's why I'm concerned about declining inflation expectations, the five-year TIPS in particular has declined below one and a half percent. The five-year forward is down from its previous levels. And the central bank has to guard against any expectations in the market that would suggest that the central bank is not going to hit its inflation target. So you have to be credible on your inflation target. So a simple - what I'm saying is that a simple step that we may be able to take or maybe the committee might consider at its October meeting would be to just take a pause on the taper, let more data accumulate and see how the U.S. is going to evolve over the rest of the year and into next year.
MCKEE: From your viewpoint do we have a disinflation/potential deflation problem? Does the Fed have a credibility problem? What's behind the collapse in expectations?
BULLARD: I think one idea that I have is that there's a global inflation factor if you had, if you put all the central banks of the world together and just had one central bank there would be one policy. That policy might be a little bit too tight, and therefore global, the global inflation factor is low certainly seems to be true based on the inflation numbers coming out of Europe. So and then we're kind of partly tied to that global inflation factor. And that's a downdraft on our inflation. So that's not really a complete theory, but that is one idea about what's driving inflation expectations lower in the U.S. despite fairly good real-side data in the U.S.
MCKEE: Well, a lot of people also point to oil prices. You can't really influence the direction of oil prices.
BULLARD: The inflation goal for the Fed is a headline inflation goal. It means that we want to hit on average over a period of years the headline inflation rate. These are prices that people actually pay. And so they're important prices. And people substitute out of goods that are more expensive than into goods that are cheaper. And that's part of the way economics works and part of the way the price index works. So I think it's important to look at the headline, even and when it's down and when it's up, but you need to look at the headline inflation rate over the medium term because that's what the goal of the policy is.
MCKEE: But you can influence the level of the dollar. And a lot of your colleagues have talked about the dollar being a drag on the economy going forward, particularly if it continues to appreciate. How worried are you and how much does it influence your thinking about what policy should be.
BULLARD: Dollar policy is up to the Treasury Secretary, and let him comment on dollar policy. The actual movements in the trade-weighted value of the dollar don't seem large to me compared to what they've been in the last 10 or 15 years. And so I don't see that as being a major factor. It's certainly a factor, but it's small, relatively small compared to other things that are going on.
MCKEE: A lot of people have suggested, not a lot of people, but a few people in the markets looking at the volatility have suggested the Fed might be forced back into a QE 4. Is there any chance of that at this point?
BULLARD: Yes. Well, I think you should quit numbering the QEs. I've been an advocate of having an open-ended program. I do think QE is our most powerful tool when the policy rate is at zero. And I think it's far more powerful than forward guidance for instance. And I think we saw that during the taper tantrum of 2013. And therefore I think I've been for having an open-ended program that reacts to economic data. And so far we've been able to taper the program down on the face of really dramatically improving labor markets this year, but maybe this is a juncture where we'd want to invoke that clause about it being data dependent.
MCKEE: One quick question about the mechanics of raising rates when you do. Market experts say that if you retain your balance sheet, don't sell anything off, the amount of reserves is just going to overwhelm the Fed funds rate and you won't be able to control the level of interest rates.
BULLARD: No. I think we have a good plan on that. We're going to use the interest rate on excess reserves as a lead indicator of policy. We're also going to use this overnight reverse repo program to put a floor under the federal funds rate, and I would say a gap between those two rates of around 25 basis points. Fed funds will then trade in between those two rates. And if all three rates more or less move in tandem then I think that will be a good way to describe policy.
MCKEE: One last question. If you're Mike Matheny, what do you do to turn the Cardinals around?
BULLARD: Well, the Cards were down to the Giants two years ago, or I'm sorry, were up on the Giants two years ago 3 to 1. We were only one game away from the World Series. And we were outscored about 24 to 2 as I recall in the last three games. And the Giants went on to win the World Series. So hopefully we can pay them back now. I think if we can win a game in San Francisco, bring it back to St. Louis we'll do well.
MCKEE: St. Louis Fed President Jim Bullard showing his Cardinal colors.
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