Thursday, January 15, 2009

Division Mounts Among Fed Officials

The swelling balance sheet at the Federal Reserve is causing problems in more ways than one. One Fed official, Philadelphia Fed bank president Charles Plosser, recently went public with his objections against current Fed policies. Plosser’s main objections concern the ballooning balance sheet and the apparent endlessness to the madness. Fed chief Ben Bernanke doesn’t think that the balance sheet is a problem, but Plosser does, and he is ready to take his argument to whoever will listen. The following are excerpts from a MarketWatch article that detail some of Plosser’s concerns:

“Plosser said that the growth of the Fed's balance sheet was a key metric. ‘It is not appropriate to ignore quantitative metrics in this new policy environment,’ Plosser said.”

“Fed officials who pay attention to the money supply believe that the Fed's current policy of printing money never ends well and the danger of inflation is very high. They believe the Fed must withdraw the stimulus before there is any sign of inflation or it is too late.”

“Plosser also argued that the Fed has put its independence at risk by buying long-term assets. He worried that some "interest groups" will try to use political persuasion to stop the Fed from selling these longer-term assets even if the central bank has decided it makes sense.”

“‘We will need to have the political fortitude to make some difficult decisions about when our policies must be reversed or unwound,’ Plosser said. Bernanke said that he would watch this situation closely but didn't expect it to be a ‘significant problem.’"

Plosser isn’t the only one expressing concerns. William Poole, who recently left his position as president of the St. Louis Fed, has also been outspoken about issues with current Fed policies. The following are experts from a MarketWatch article:

“Poole said the expansion of the Fed's balance sheet is unprecedented and research suggests that a surge of inflation is sure to follow. ‘I would say if the policy is not reversed, there is a high probability that the unpleasant risk (of inflation) materializes,’ Poole said in an interview.”

“‘I believe that the Fed should set a hard number—a target that they take seriously for the overall size of the balance sheet,’ he said.”

“Poole said he was very concerned that the Fed could simply lend money to anyone, without constraint.”

“In the Soviet Union and Eastern Europe during the Cold War era, economies were inefficient because they had a soft-budget constraint. If a firm got into trouble, the banking system would give them more money, Poole said. The current situation at the Fed seems eerily similar, he said.”

"’What is discipline—where are the hard choices—when does Fed say our resources are exhausted?’ Poole asked.”

Bernanke seems content to continue on the current path, but it should at least be a little concerning that the opposition inside the Fed is becoming more vocal. I would venture to guess that there are others that oppose Bernanke, but they do not have the guts to stand up publicly against him. If things continue to worsen, it will be at least interesting to see how much the opposition ranks swell.

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