Plosser: Stop QE By Yearend and Make Thresholds Triggers

Charles I. Plosser (FRB-Phil.), a nonvoting participant on the FOMC, gave a speech today titled, “Assessing Monetary Policy.” He flies with the FOMC’s hawks. He is more optimistic than most of his colleagues about the US economy. He sees the unemployment rate approaching 7% by the end of this year and 6.5% before the end of 2014. He wants to start tapering QE now and stop purchasing assets by the end of the year. He wants to change the forward guidance on the fed funds rate path by treating the 6.5% unemployment rate and the 2.5% inflation rate as triggers rather than thresholds. In his own words:

In my view, it is important that we end purchases before we reach the 6.5 percent threshold for considering an increase in the funds rate target. If we don't, I believe the 6.5 percent threshold will lose meaning. Would anyone believe we would raise the fed funds rate at the same time that we are increasing the size of the balance sheet through asset purchases? Thus, consistent with my forecast and with the Committee's forward guidance, I favor starting to reduce the pace of purchases and ending the asset purchase program by year-end.

Here is why he prefers targets to thresholds:

In August 2011, the Committee began using dates to signal when the policy rate might increase, but it changed those dates at subsequent meetings. The FOMC then opted to formulate its forward guidance in terms of thresholds for unemployment and inflation. This is preferable to calendar dates because it is state contingent. Yet, the FOMC has specifically said that the thresholds are not triggers — they are not firm commitments and they may change. The Committee has repeatedly opted for language that allows a great deal of discretion to behave as it chooses, depending on the circumstances. But effective forward guidance demands commitment. When the Committee stresses the general flexibility of its policy decisions or makes vague references to data dependency, it does little to clarify the FOMC's intentions about future policy, even though clarity is what the FOMC wants to provide to the markets through its forward guidance. Thus, there is a fundamental tension between wanting to provide clarity as to the forward course of policy and wanting to maintain complete discretion. The Committee has failed to address this tension, which undermines the effectiveness of its policy.