Fed’s Plosser on default risk, inflation, and more

July 21, 2011

The following are highlights from a Reuters interview with Philadelphia Federal Reserve Bank President Charles Plosser on Wednesday.


“Clearly if something were to happen and financial markets were to seize up, and there were liquidity problems or financial market disruptions, I think the Fed would feel like it had the responsibility to go in and keep markets functioning, as a lender of last resort.”

“We have to be very careful that we don’t become, that we don’t conduct fiscal policy in this context. That we don’t substitute for the inability of the Treasury to borrow in some circumstances. That would be a bad policy decision from my perspective.”


“There are other issues: how do you think about collateral. Banks borrow at the discount window against good collateral. How do we treat collateral if it happens to be Treasuries and they’ve defaulted? Do we treat them as if they didn’t default, in which case we would be saying we are pretending it never happened? Or do we treat them as if they defaulted and don’t lend against them?”

“Those types of questions — as opposed to just how you manage the Treasury’s checkbook — thinking about how we think about valuing defaulted securities or securities whose interest payments have been missed, there is a really difficult … those are more policy questions than operational.”


“The Fed over the last three or four months, has worked very closely with Treasury on technical issues, such as how you would deal with a potential default.”

“How would you deal with Treasury’s checking account? How are we going to communicate with the Treasury about what gets paid and what doesn’t get paid.”

“Most of it can be handled. We are developing processes and procedures by which the Treasury communicates to us what we are going to do. A lot of it is just cash management issues, how do you manage this stuff.”


“I still think that for the second half of this year that 3 or 3-1/2 percent growth is the most likely outcome, but you know that’s a forecast, it could be wrong. … I’m still looking at a 3 and 3-1/2 percent range for 2012 and 2013 and, of course, my philosophy about monetary policy is really about hitting targets over the medium to longer-term. … A lot of what we’ve seen in terms of the slowdown has been easily identifiable with some transitory factors. … I don’t see the fundamentals of the economy as changed that much. Yeah, there’s been some shocks and disruptions but the underlying forces that are going to cause us to continue a slow, moderate recovery are still in place.”


“We’re now in a position where, if we see the economy growing at 3 to 3-1/2 percent in the second half of the year, regardless of what’s happened in the past, over the first half, and we still see inflation kind of creeping up on us, it’s a very different set of circumstances (from when the Fed approved its last round of bond purchases in November) that might suggest that there might be a cause for a change in the course of policy. … I could see circumstances evolving in a way where (a tightening in the second half of this year) that would be called for, absolutely. … If you thought policy was correct last fall, in December, because you were worried about deflation, now inflation is three-quarters of a percentage point higher than it was in December. What does that suggest? Well it suggests, perhaps, you could argue, perhaps, that if policy was right in December and now inflation is another three-quarters of a percentage point higher, now policy is too loose. … That’s one of the fundamental questions I’m trying to grapple with… If you thought policy was right last fall, then it can’t be right now. … The more my forecast comes to fruition, the more I’m going to feel like we may have to act. … I’d like to have a little more confidence in that forecast.”


“I still think inflation risks are to the upside. People sometimes misinterpret that when I say inflation risks are to the upside that I’m talking about what’s going to happen this month or this quarter. That’s not where my concern is, it’s over like a year or 18-month or two-year horizon.”


“I think it’s a little bit disappointing that the numbers have gone up but I haven’t really changed (my jobless rate forecast) a whole lot. If I saw two more months of that, if it kept going up, obviously I’d begin to think differently about it. I think there’s just been a lot of volatility recently, so I don’t want to overreact to the news. So, I guess the way to put it, I’m cautiously optimistic on that forecast.”


“For me the hurdle rate is pretty high. Are there circumstances: yes, if we had another financial meltdown because of something happening in Europe and markets just sort of fell apart, well, yeah, the Fed would obviously try to step in and do what it can to address that sort of massive shock. But I think that the ability of monetary policy now to do much about the pace of the recovery is pretty minimal. … Monetary policy is not a freebie. There are costs to engaging in easing. We have to be mindful not only of the potential benefits but the potential costs to that. Given that I feel that inflation risks are still clear to the upside and that I believe that the ability of further easing to do much about what the serious problem is — which is unemployment — that our ability to do much about that is very limited, the hurdle rate, as I said, would have to be pretty high. … We don’t have a problem with deflation right now, that’s not the problem it may be exactly the opposite problem.”


“We are in contingency planning mode. … We are all engaged. Some of this is occurring in different (Fed) committees, different structures in the system depending on the issues involved, but we are all engaged in this. It’s a very active process.”

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