Monday, 01 Nov 2010 08:59 AM
Slight deflation is just as acceptable as low inflation, said
a senior Federal Reserve official who has persistently dissented
against Fed easy money policies, repeating that further easing
would be dangerous.
Kansas City Federal Reserve Bank President Thomas Hoenig said
the Fed should not have an inflation target but he would like to
see an inflation rate of zero.
Prospects of very low inflation, and the resulting low nominal
interest rates that give a central bank little room to cut rates
sharply in a crisis, is misplaced as it does not allow monetary
policy enough time to take effect, Hoenig said in an interview
in Saturday's issue of Swiss daily Neue Zuercher Zeitung.
The interview with Hoenig, who has used all six of his votes in
2010 to dissent against the Fed's pledge to hold rates
"exceptionally low" for "an extended period," was conducted on
October 26 -- the same day that Hoenig warned in a speech that
further easing could be dangerous.
The Fed is expected to approve a new round of "quantitative
easing" -- essentially printing money by buying bonds -- at its
next policy meeting on November 2/3 because many senior
officials fear that low inflation could turn into deflation that
would make it harder for companies and households to pay off
their debts -- already a drag on the U.S. economy.
VOTE
Under the Fed's system of rotating voting positions for regional
bank presidents, Hoenig has a vote on the policy-making federal
open-market committee (FOMC) this year but not in 2011.
"A little deflation is no worse than a little inflation," Hoenig
said in the interview, published in German.
The situation was not comparable with the Great Depression, when
prices fell by 20 percent, which was just as bad as price
increases of 20 percent, he said.
"Wanting higher inflation is not the same as preventing strong
deflation," Hoenig said.
A central bank should aim over time to hold prices stable, or at
most tolerate very low inflation, and it was dangerous to argue
that monetary policy could reduce unemployment without stoking
inflation.
Hoenig said that quantitative easing had succeeded in
kick-starting the financial markets but now it had diminishing
returns and now that the crisis was over the Fed should allow
markets to function normally and reduce its portfolio by
allowing bonds it had purchased to mature.
Hoenig cited estimates that long-term rates would fall 25-30
basis points if the Fed embarked on a new round of large-scale
quantitative easing.
The Fed had always been quick to pump money into the system in a
crisis but slow to withdraw liquidity afterwards, he said.
"Thus the Fed is risking higher inflation for a very small
incremental benefit in the form of slightly lower long-term
interest rates. I'm not prepared to run that risk," he said.
Hoenig recalled that the Fed had eased monetary policy sharply
in 2003 as an insurance against deflation.
"We paid a horrific premium for that if you look at the recent
recession. I still believe that the costs of such a policy are
higher than generally assumed," he said.
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