Friday, October 1, 2010

Fed: Another $550B in QE Is Like 0.75% Off Interest Rates; Further Action Likely

William Dudley, president of the Federal Reserve Bank of New York, says that mMore action by the Federal Reserve will likely be needed, adding that current conditions of high unemployment and low inflation are unacceptable.

"Further action is likely to be warranted unless the economic outlook evolves in such a way that makes me more confident that we will see better outcomes for both employment and inflation before too long,"
[...] the costs of the tools the Fed has available to ease policy further "do not appear prohibitive".

Reuters: "Dudley said $500 billion of purchases would likely have about the same impact as a 0.5 or 0.75 percentage point decline in the Fed's benchmark federal funds rate", .describing as "too dark the view that lowering borrowing costs further would be ineffective, or akin to pushing on a string".

"Although the responsiveness of demand to reductions in interest rates is probably lower in a world in which balance sheet constraints are important, the responsiveness is not zero,"  "I believe that it remains significant."

"By clarifying our intentions, we can reduce the risk of further disinflation," "
Disinflation is a problem, [...] as it can cause inflation expectations to fall, increasing the real cost of credit".

"If we judged it desirable, we could go still further and provide more guidance on how monetary policy would react to deviations from any stated inflation objective,".

Dudley also said a risk is that a bigger balance sheet could cause inflation expectations to become unanchored and that the Fed would have to be clear it has a credible exit strategy in place.

He said he was "very mindful" of concerns that more Fed purchases could be seen as a policy of monetizing the debt, but said this view is "fundamentally mistaken".

"The longer the U.S. economy is stuck with the current level of slack and disinflationary pressure,  the greater the likelihood that a further shock could push us still further from our dual mandate objectives and closer to outright deflation."

"We have tools that can provide additional stimulus at costs that do not appear prohibitive."

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