The Fed’s Lone Dissenter
Last week’s Fed meeting was fairly innocuous. They kept rates where they were. They kept their QE in place. The language in the press release didn’t change much. Yet the one thing that struck me was the almost unanimous decision. At this meeting, as with the last several meetings, Jeffrey M. Lacker – president of the Richmond Fed, was the lone dissenter on the Fed’s Open Market Committee (FOMC). Now in my opinion, neither unanimous nor hotly partisan decisions are as interesting as an “almost unanimous” decision. I keep wondering, what does that one guy know that the others don’t…or vice versa.
The official statement from the Fed had this to say,
Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and disagreed with the description of the time period over which a highly accommodative stance of monetary policy will remain appropriate and exceptionally low levels for the federal funds rate are likely to be warranted.
So, I set off to find out what’s behind Lacker’s thinking and see if I agree with that thinking. Actually, I didn’t have to look very far to come across some of Lacker’s reasoning. In a speech to the Roanoke Regional Chamber of Commerce on October 15, Lacker gave his economic outlook and closed with his thoughts on the recent Fed actions. Lacker spells out essentially two points where he disagrees with the majority Fed opinion:
First, he addresses what he feels are issues with the forward guidance in the Fed’s statement. In Lacker’s words,
[The forward guidance] could be misinterpreted as meaning that the Committee believes the economy will be weaker than people had thought. By itself, that could have a dampening effect on current activity, which is not what was intended. On the other hand, it also could be misinterpreted as suggesting a diminished commitment to keeping inflation at 2 percent. I would vigorously oppose adopting such a stance, and I do not believe my colleagues on the FOMC intended that interpretation either.
On this point, I can see where President Lacker is coming from. I feel the change in the Fed’s communication has been effective, but I’ll concede that it may need to change somewhat soon. I’m a strong believer that it’s probably good to get inflation expectations higher. The Fed should want markets to know that it is unlikely to swiftly clamp down on accommodative policy should the inflation edge above 2% or 2.5%. As market watchers saw inflation creeping up, uncertainty would set in as to whether the Fed would keep their foot on the gas pedal, so to speak. If Lacker’s intention is to insert more specific language around what kind of inflation the Fed will accept in the short term, then I’d agree with him.
His second point surrounds the purchase of mortgage-backed securities (MBS). He first states that he doesn’t think the impact is likely to amount to much, then takes issue with the choice of MBS as a policy tool.
Buying MBS rather than Treasuries may reduce borrowing rates for conforming home mortgages, but if so, it will raise interest rates for other borrowers and thus distort credit flows. This is an inappropriate role for the Fed, a principle that was recognized in the Joint Statement of the Department of Treasury and the Federal Reserve on March 23, 2009: “Government decisions to influence the allocation of credit are the province of the fiscal authorities,” that is, Congress and the administration.
On this point, I could go both ways. On the one hand, purchasing agency MBS doesn’t seem to be directly applicable to the Fed’s mandates of price stability and full employment. On the other hand, the Fed is purchasing MBS at time that the housing market is bouncing back, so maybe incremental downward pressure on mortgage rates will boost mortgage demand. But, I also don’t know how much weight I give to the idea that lowering rates on conforming loans won’t help those with non-conforming loans.
I also think there is merit to Lacker’s concerns about Fed actions distorting credit markets. While I do think Fed actions to buy MBS after Lehman were absolutely needed to repair bank balance sheets, and I also believe we need to continue to keeps rates low to get the economy going, I think that there are unintended consequences of the low-rate environment. If rates are actually below what the market would set, then savers are not being properly compensated for risk. In addition, even if the low rates are the correct rates, we are harming savers while borrowers benefit and it remains to be seen what the longer-term effects are on demanders of low-risk assets (say pension and insurance companies) and how people save for retirement or continue to grow their wealth during retirement.
To conclude, even though I do not fully agree with Lacker, I appreciate his consistent dissent. A healthy argument between competing views always leads to a better outcome. If only Congress could be as productive as the Fed… (that’s another argument for another venue.)