Fed stimulus benefits still outweigh risks, Lockhart tells Reuters

February 20, 2013

The Federal Reserve is cognizant of the potential costs of its unconventional policies, but the economic benefits from asset purchases are still far greater than the potential costs, Atlanta Fed President Dennis Lockhart told Reuters in an interview from his offices.

What follows is an edited transcript of the interview.

The December meeting minutes seemed to signal a shift in sentiment at the central bank toward a greater focus on the policy’s costs. How concerned are you about the risks from QE? Has the cost/benefit tradeoff changed for you? What’s your sense of how long you’ll need to keep going?

I would not say at this point that, in any respect, the costs, which are largely longer-term and speculative, outweigh the benefits of maintaining a highly accommodative climate that is being contributed to by both large-scale asset purchases and our interest rate policy. Having said that, I think policymakers have to be aware that in a policy such as quantitative easing or large-scale asset purchases, continuing to build up the challenge of reversal of that policy, or the challenge of normalization, has to be on your mind. I don’t think we’ve gotten to the point where the costs outweigh the benefits. I’m a believer, although of course it’s very hard to isolate cause and effect in the real world, that our policy has benefited the economy and that the improving situation that we are now seeing is at least in part a result of monetary policy.

How does QE3’s effectiveness compare to prior rounds of asset purchases?

Let me first answer that by arguing that each round had a different purpose. The first round had largely a liquidity provision purpose. The second round was, for the most part, to reverse declining inflation expectations that looked dangerous, worrisome. This round, my characterization of it is, to give a boost to the economy, to add to momentum, as it seemed to be emerging from a long period of sluggish growth. So each round in a way was focused on a different kind of problem.

We have a long way to go, particularly in the employment realm, before the economy reaches its full potential. Therefore the continuation of this highly accommodative stance that includes the efforts of quantitative easing, is appropriate, is a sensible policy.

What’s your sense of the growth outlook? The fiscal cliff has sort of been resolved, we still have the sequester hanging on the horizon. Some of the more gigantic uncertainties have been lifted – the cliff and the prospect of a euro collapse. Do you think that there’s any upside risk to growth from this removal of uncertainty?

I am moving towards a view of balanced risks. Next time I’m asked I’ll probably take that position.

I take it that would that be the first time in a long time?

It had been a while. I had viewed the risks to the downside through most of 2012 and I’m beginning to convince myself that the risks are balanced. Which means we could do better than what my formal outlook for growth is for the year, which is 2 to 2-1/2 percent. That range is basically a continuation of the relatively slow growth we’ve seen ever since the recovery began.

If we can navigate through some of these fiscal questions in a way that does not create a blow to confidence or some kind of political crisis that really hurts domestic consumer confidence as well as business confidence, I think there are some positive signs in the economy that suggest we could do better than that range of 2 to 2-1/2 percent this year.

As far as payroll growth, is there a particular number you’re looking at? People are trying to hone in what substantial improvement means.

My approach to the expression ‘substantial improvement in the outlook for the labor markets’ is to look at a lot of data and not fixate on the unemployment rate. The unemployment rate can go up for good reasons and bad reasons. You have to look at the unemployment rate, understand its internal dynamics, and then decide whether it’s indicative of a number of labor market conditions.

A hundred and fifty thousand jobs a month is not going to create a lot of progress. So clearly we would hope for a number north of that level, which has been for the last several months pretty much the average. So I think we need to see an improvement on that if we’re going to get to at least from an unemployment rate point of view, substantial improvement in the immediate term.

How do you assess the likely timing (of a QE pullback)? If it takes substantial improvement and we’re not there yet do you think the market is being fair in pricing asset buys until the end of the year, maybe until early next year? What’s your sense of when the ship will start to turn?

The policy calculation around those questions is diffuse. Let me characterize it this way. I think there are probably observers in the market and perhaps colleagues who still hold out the hope that we’ll see a low enough unemployment rate per se to justify the claim that we have seen substantial improvement and maybe begin to slow down, taper off or set an end-date for quantitative easing. I think there are others who are looking at this as something quite a bit more than just the unemployment rate and who might therefore believe we need to go on with this policy until we reach a different definition of substantial improvement.

There may be a third group then, that says we will probably see significant improvement, or we hope we will see significant improvement. Whether it amounts to substantial is another question, depending on how you define that; and in any event the large-scale asset purchase program ought to be thought of as not an indefinite policy program, but something that is temporary, meant to help with momentum of the economy. So I think opinion, external and even internal, is diffuse, not terribly well defined. There’s a little bit of ‘in the eye of the beholder’ aspect to deciding whether substantial improvement has been accomplish.

I don’t want to speculate how long the program will go – that’s a committee decision. I do believe that we’re not going to see enough improvement in the very short term to claim victory on the substantial improvement idea. Therefore my recommendation would be to continue (buying assets) through the end of the second half (of 2013).

Now, on the risks side, I wanted to ask you – what are your personal concerns? You have a banking background, you have a feel for the markets? Do you agree with (Fed Board Governor Jeremy) Stein that there are signs of overheating?

I would not at this stage. I don’t see really strong signs of either a bubble developing or overheating. I do think that we live in a risk-on/risk-off world, and a lot of risk has been taken on because of a somewhat better outlook. So, does that mean at some stage there is a correction that takes place? Possibly.

But as to risks, I think the most important risk relates to our fiscal situation. There are some important milestones that have to be navigated this year by the administration and Congress. That concerns me. I would hate to see a set of issues around fiscal concerns turn into an unexpected trauma for the country politically that did harm to the momentum of the economy.

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