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New York Federal Reserve Bank President William Dudley said the Fed has the tools to prevent inflation from accelerating and doesn’t need to begin trimming its balance sheet.
“It’s a little bit premature to be so confident that you want to pull all these things back right now, because the economy still isn’t growing very fast and we do have a very high unemployment rate,” Dudley said Monday in an interview on CNBC.
Dudley’s comments are in contrast to those of two Fed district bank presidents, Jeffrey Lacker and James Bullard, who said the central bank may not need to buy the full $1.25 trillion in mortgage-backed securities that has been authorized by year-end. Richmond’s Lacker and Bullard, of St. Louis, spoke at separate events last week.
“Obviously, as financial conditions improve, as the economy does somewhat better, which seems to be the trajectory they’re on, it’s a legitimate point to consider what you want to do in terms of your purchase programs,” Dudley said Monday.
The central bank, seeking to stimulate the economy and unclog credit markets, has created emergency lending programs and doubled the size of its assets during the past year to more than $2 trillion.
The Fed’s program to buy mortgage bonds guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae is aimed at reducing home-finance costs and arresting the housing slump that triggered the recession. The central bank also intends to buy $300 billion of long-term Treasuries and $200 billion of federal agency debt.
Dudley said it’s “more likely than not” that policy makers will follow through with the full amount of purchases. While he hasn’t decided how he would vote, investors’ expectations will influence his opinion on the issue, he said.
“The market expects us to complete these programs, to do the full amount,” he said. “To contradict that market expectation is a pretty high hurdle.”
Mortgage-backed securities purchases “have been very effective,” he said. “There’s no question that has actually helped.”
The difference between yields on Washington-based Fannie Mae’s current-coupon 30-year fixed-rate mortgage securities and 10-year Treasuries has fallen to 103.5 basis points as of 9:27 a.m. in New York from 153.2 basis points on March 18, according to date compiled by Bloomberg. A basis point is 0.01 percentage point.
The impact from the Treasury purchase program is “more ambiguous” because it’s much smaller, Dudley said. The effort was aimed at creating additional stimulus when the fed funds rate was already near zero, and was not an effort to “monetize” the U.S. national debt, he said.
The Fed’s lending programs have led to a large expansion in the reserves banks keep at the central bank. Dudley said those reserves can be drained from the system before leading to an increase in lending and worsening inflation.
“My view is we have tools to manage our balance sheet so we’re not going to have an inflation outcome, a bad inflation outcome,” Dudley said.
There is no sign the Fed’s actions spurred a rise in prices. Consumer prices were unchanged in July, and compared with a year earlier, they were down 2.1 percent, the biggest 12-month decrease since 1950.
Dudley said the Fed is “far along” in its planning for an exit from the extraordinary policy actions of the past year. Along with paying interest on excess reserves, the central bank may also do reverse repurchase agreements, lending securities into the market in exchange for cash, and create special interest-bearing accounts at the Fed for banks to deposit their excess reserves.
The timing for various aspects of the exit “remains to be seen” because the Fed will need to weigh the desired impact on parts of the market: mortgage rates or short- or long-term rates, he said. “We’re going to base it on the facts at this time, which I think is quite a long period away.”
The New York Fed president said he wouldn’t give in to any political pressure to keep interest rates low for too long.
“I am committed to taking away the punch bowl at the right time,” he said. “I have no desire whatsoever to see inflation get out of control.”
The health of the banking system is a worry, with “a tremendous amount of additional credit losses” expected, Dudley said. “The banking sector is not as good as it normally would be at this stage of the economic cycle.”
Dudley said he’s concerned that banks continued to pay dividends and buy back stock during the financial crisis, dissipating their capital.
“We need to think harder about the regulatory regime” he said, and consider imposing an automatic ban on dividend payments by lenders when “the bank stock price plummets and the banks aren’t doing well.”
Banks “probably need” to raise additional capital, he said. One possibility would be through a “contingent capital” program, allowing banks to issue debt convertible into equity capital if their stock price falls.
Fed officials have learned from their errors, Dudley said. “On the supervision side, I think it’s fair to say that we could have been tougher. We probably could have been smarter.”
