Fed Is Split Over Timing of Rate RiseCorporate Law Center in The New York Times, October 09, 2009
The New York Times
October 9, 2009
Fed Is Split Over Timing of Rate Rise
By EDMUND L. ANDREWS
WASHINGTON — Fissures are developing among policy makers at the Federal Reserve as they debate how and when to start raising the benchmark interest rate from its current level just above zero.
With Fed officials forecasting that unemployment will average 9.8 percent in 2010, nobody appears to be arguing that monetary policy should be tightened anytime soon. The central bank’s official mantra continues to be that the overnight federal funds rate will remain “exceptionally low” for “an extended period.”
But Fed officials have hinted at new disagreement in recent weeks. The arguments go beyond the traditional split between hawks, who worry that easy money will stoke inflation, and doves, who contend that unemployment is the top problem.
The more devilish debates are about how fast to act once the decision has been made, and how to carry it out. Beyond raising the overnight federal funds rate, the Fed also has to unwind $2 trillion in special programs that prop up paralyzed banks and credit markets.
Where Ben S. Bernanke, the Fed chairman, stands in the emerging argument is a question mark. At a conference held by the Fed on Thursday evening, he assured economists that the central bank had a detailed list of tools to reverse course but offered no new hint of when he planned to begin his exit strategy.
“When the economic outlook has improved sufficiently, we will be prepared to tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration,” Mr. Bernanke promised.
Any move to tighten monetary policy over the next year or so could set the stage for a clash between the Fed and the White House. The Obama administration has been outspoken in saying it does not want a quick end to stimulus policies, whether fiscal or monetary.
Policy makers are haunted by the results of previous miscalculations. Mr. Bernanke and others have warned that the central bank should not repeat its error in 1937, when it raised interest rates too early and helped extend the Depression for several years.
At the same time, officials at the Fed are acutely aware that it has been widely blamed for contributing to the housing bubble and the financial collapse by keeping the cost of borrowing too low for too long after the recession of 2001.
One hint of the discord came Tuesday, in a speech by Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City.
Though he stopped short of calling for immediate rate increases, Mr. Hoenig made it clear that he was getting impatient.
“My experience tells me that we will need to remove our very accommodative policy sooner rather than later,” he told an audience of business executives. “Even if we were to start immediately, much time would pass before incremental increases could be considered tight or even neutral policy.”
Mr. Hoenig is not currently a voting member of the Fed’s policy committee, on which the regional Fed presidents hold rotating seats, but he presents his views at all meetings.
And he is not alone.
Richard Fisher, president of the Federal Reserve Bank of Dallas, sent a similar message in a speech on Sept. 29. “That wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction,” he told a business group.
Other Fed officials with similar views include Jeffrey M. Lacker, president of the Federal Reserve Bank of Richmond; Charles I. Plosser, president of the Philadelphia Fed; and Kevin M. Warsh, an influential Fed governor.
By contrast, some top Fed officials in Washington and New York have repeatedly emphasized that the economy is still extremely weak and that unemployment, already at its highest level since the early 1980s, will probably climb above 10 percent and remain high for several years.
“The turnaround is certainly welcome, but it shouldn’t be overstated,” Daniel K. Tarullo, a Fed governor, said on Thursday in an address to a civic group in Phoenix. “The employment situation continues to be dismal.”
William C. Dudley, president of the New York Fed, presented a detailed case that seemed aimed at responding to those calling for a quick end to low rates.
“Some observers are concerned that this expansion will ultimately prove to be inflationary,” he told an audience at the Corporate Law Center at Fordham University. “This concern is not well founded.”
Mr. Dudley noted that unemployment among working-age men was 10.3 percent — higher than in any other downturn since World War II.
On top of that, he said consumers were reeling from the “wealth shock” caused by the collapse in home prices and by losses to their stock portfolios. That could cause people to increase their saving rate, meaning less consumer spending in the short run.
Finally, Mr. Dudley cautioned that banks faced another wave of losses from loans tied to commercial real estate.
Beyond the disagreements about the relative dangers of rising prices versus rising joblessness, Fed officials are grappling with how to decide on the need for higher interest rates.
Mr. Bernanke and other officials want to see evidence that the economic recovery is self-sustaining, strong enough to generate jobs without the crutch of extremely low interest rates.
But Mr. Warsh, as a Fed governor, has begun arguing that the central bank cannot afford to wait for irrefutable evidence of a solid expansion. Mr. Warsh recently argued that the Fed should take at least some of its cue from stock prices and other financial indicators, which turn around earlier and more quickly than the underlying economy.
“If policy makers insist on waiting until the level of real activity has plainly and substantially returned to normal,” he warned in a speech on Sept. 25, “they will have almost certainly waited too long.”
Mr. Warsh and some other Fed officials also argue that when the time does come to change gears, the central bank may have to raise rates almost as fast as it slashed them when the crisis began.
It remains unclear whether Mr. Bernanke agrees with that idea, though he and other Fed officials have emphasized that they have planned carefully for the Fed’s exit strategy and have all the tools in place to reduce the special support programs quickly.