What Are the Risks and Costs of Expanding the Federal Reserve's Balance Sheet?
Does anybody understand what Richard Fisher is talking about here?
Fed’s Fisher Worries About ‘Hotel California’ Monetary Policy: Dallas Fed President Richard Fisher said Friday on CNBC he opposed the Federal Open Market Committee‘s recent decision on employment thresholds and that he was extremely concerned that it would become increasingly difficult to exit the Fed’s accomodative monetary policy.
We are at risk of what I call a ‘Hotel California’ monetary policy, referring to the Eagles’ song, where we can check out any time we want from this program, but we can never leave….
We’ve done enough… businesses are awash in liquidity…. We cannot count on central banks to carry an economy. There has to be the right incentives to take what the central banks do, provide monetary stability, provide just the right amount of liquidity to the economy, incentives to put all that to work, and grow the economy...
Does anybody understand what Richard Fisher means?
Ben Bernanke, at his press conference on Wednesday, talks a lot about costs and risks of expanding the balance sheet, but specifies one and one factor only--that medium-term inflation expectations may become unanchored as investors conclude that enlargement of the balance sheet will never be shrunk down to normal, that as a result inflation expectations will become un-anchored, and that as a result of higher inflation expectations the Federal Reserve will have to maintain unemployment on average above the natural rate in order to hit its 2%/year inflation target. He specifies no other risks or costs of enlarging the balance sheet:
[T]he Committee will be monitoring economic and financial developments to assess both the efficacy and possible drawbacks of its asset purchase program….
If future evidence suggests that the program’s effectiveness has declined, or if potential unintended side effects or risks become apparent as the balance sheet grows, we will modify the program as appropriate….
[T]he asset purchases are a less well understood tool. We will be learning over time about how efficacious they are, about what costs they may carry with them in terms of unintended consequences they might create….
W]e have announced an initial amount of $85 billion/month in purchases. We are prepared to vary that as new information comes in….
[W]e will also be looking at the efficacy and costs of our program and if we find that it is not working as well as we had hoped or if various costs are emerging that we had not anticipated then that would also have to be taken into account….
[W]e are now in the world of unconventional policy, it has both uncertain costs….
[I]f the balance sheet gets indefinitely large there would be potential risks in terms of financial stability, in terms of market functioning, and the committee takes these risks very seriously. They impose a certain cost on policy that does not exist when you are dealing only with the Federal Funds rate….
[T]he reality [is] that as the balance sheet gets bigger there are greater costs that might be associated with that and those have to be taken into account….
[W]ith the balance sheet already large… the ability to provide additional accommodation is not unlimited. That is just a reality….
We have been increasing our balance sheet for some time. We have been very clear that this is a temporary measure. It is a way to provide additional accommodation to an economy that needs support. We have been equally clear that we will normalize the balance sheet, that we will reduce the size of our holdings, whether by letting them run off or by selling assets in the future. This is again only a temporary step. It would be quite a different matter if we were buying these assets and holding them indefinitely. That would be a monetization. We are not doing that. We are very clear about our intentions. And I think up until now it seems that our credibility has been quite good. There is not any sign either of current inflation or of any increases in inflation expectations—looking at financial markets, looking at surveys. This is one of the things that we have to look at. Remember, I talked earlier about the potential costs of a large balance sheet. We want to be sure that there is no misunderstanding, no effect on inflation expectations from the size of our balance sheet…
