Gov. Powell Says QE Is Unconventional with Uncertain Risk

In a speech today, Governor Jerome H. Powell suggested he prefers forward guidance about interest rates over QE:

By stating an intention to hold rates low and linking that intention to the path of the economy, forward guidance affects the path of longer-term rates and allows the market to make adjustments to these rates as economic conditions evolve.

Regarding QE, he was a bit less sure of its effectiveness:

By purchasing and holding large amounts of Treasury securities and MBS, we put additional downward pressure on term premiums and so on long-term rates. Asset purchases are an innovative, unconventional policy. Their likely benefits may be accompanied by costs and risks, the nature and size of which remain uncertain.

He believes that QE1 worked very well to end the financial crisis. He also believes that QE2 averted deflation. What about subsequent asset-purchasing programs? He thinks they have been effective, on balance, though “the evidence across channels is mixed.” His biggest concern about QE is that it may cause asset bubbles and financial instability:

With inflation in check, the most important potential risk, in my view, is that of financial instability. One concern is that our policies might drive excessive risk-taking or create bubbles in financial assets or housing. A related worry is that the eventual process of reducing purchases and normalizing the balance sheet may itself be destabilizing or disruptive to the economy.

Powell briefly mentioned that both equity and home valuations seem fairly valued. However, he shares the concerns of Fed Governor Jeremy Stein about excesses in the credit markets, which have been somewhat reduced by the rise in interest rates since mid-May.

Powell remains concerned about the unemployment problem and stressed that too many people who would like full-time jobs are working part time. He also noted that the number of people who have been unemployed for six months or more remains very high at 4.4 million, or 37% of the unemployed.

Nevertheless, Powell agrees with the FOMC consensus view that the headline unemployment rate should fall to 7% by mid-2014, which “would constitute a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced the current program of asset purchases.” However, he said that he wants to “emphasize the importance of data over date.” In other words, the outlook for QE will depend on the course of the economy.