Daniel Tarullo’s dovish war cry

October 21, 2011

It was his first speech on the economy in almost three years in office, but Daniel Tarullo did not pull any punches. The Federal Reserve Board governor, who tends to focus primarily on regulation, on Thursday called for the central bank to step up its purchases of mortgage bonds:

I believe we should move back up toward the top of the list of options the large-scale purchase of additional mortgage-backed securities (MBS), something the FOMC first did in November 2008 and then in greater amounts beginning in March 2009 in order to provide more support to mortgage lending and housing markets.

More broadly, Tarullo made a strong call for further monetary easing, arguing quite dovishly that the recovery is still too weak for the central bank not to take further action.

There is need, and ample room, for additional measures to increase aggregate demand in the near to medium term, particularly in light of the limited upside risks to inflation over the medium term.

Tarullo’s rather unexpected push for “large-scale” MBS buys shows just how varied a range of approaches to unconventional monetary policy the Fed is considering as its ultra-easy monetary policy fails to spur growth rapid enough to put a dent in the 9.1 percent unemployment rate. Other doves on the Committee, like Eric Rosengren at the Boston Fed and Charles Evans in Chicago, are calling for more explicit policy targets that tie the path of policy to inflation and unemployment rates.

Not that mortgage-backed securities purchases are a new idea. The Fed bought about $1.25 trillion of them as part of its quantitative easing measures. It also revived the program in a smaller form in September, when it decided to reinvest principal payments on maturing mortgage and agency bonds back into real estate finance. But until recently, a large-scale MBS program appeared to have been ruled out, particularly given the internal opposition against the purchases made in 2008-2009.

Just this week, Jeffrey Lacker, a regional Fed president who rotates into a voting seat on the Federal Open Market Committee next year, said the central bank should potentially be thinking about tightening policy, not easing further. And he questioned the idea that agency-backed mortgage bonds would have the intended effect:

I recognize the potential value of reducing retail mortgage rates by reducing the spread between AMBS and Treasuries. But doing so will cause an offsetting increase in the rates charged to other borrowers, and it’s not obvious whether the net effect on borrowing or growth will be positive or negative. More broadly, it’s simply inappropriate, in my view, for a central bank to attempt to channel credit toward some economic sectors and away from others.

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