DENVER Kansas City Federal Reserve President Thomas Hoenig, who all year has steadfastly opposed the Fed's super-easy monetary policy, fleshed out his stance against further easing on Tuesday, saying it would do little to aid recovery and could spark inflation.
The Fed has kept interest rates near zero since December 2008, and bought $1.7 trillion in mortgage-back securities and Treasuries to support economic recovery.
Markets are pricing in expectations the Fed will move to drive down interest rates further to help boost the economy, restarting Treasury purchases as soon as next month in a new round of quantitative easing, or QE2 as it has come to be known.
"We have to recognize that QE2, while a possibility, is not necessarily what we want to do given the benefits versus the risks," Hoenig told the National Association of Business Economics. "At this point, with a modest recovery under way and inflation low and stable, I believe the economy would be better served by beginning to normalize monetary policy."
Expectations of further monetary easing in the United States have already pushed up currencies in countries from Latin America to Asia, prompting loud complaints.
Hoenig, as one of the Fed's most consistent hawks more concerned with the threat of inflation than unemployment, said the Fed needs to be mindful of such spillover effects.
"We are not an island," he said. "We affect other countries, they know that and they react to us, and therefore we are affected by our actions as it comes back to us."
Many analysts believe that the Fed has signaled so strongly that further easing is imminent that it cannot back down without disrupting bond markets.
Hoenig took exception to that view, saying the Fed's responsibility is to the broader public, not just the financial markets.
"We have to do what we think is right - they have to adjust their policies accordingly, not us," he said.
In any event, he argued, further purchases of Treasuries would not drive down interest rates by much.
While New York Fed President William Dudley, a dove and influential member of the Fed's policy-making committee, recently suggested the purchase of $500 billion in Treasuries would equate to cutting short-term rates by 50 to 75 basis points, Hoenig said the effect could be less than 10 to 25 basis points.
Even with slightly lower interest rates, he said, the effect on the economy of a second round of quantitative easing would be minor.
"There simply is no strong evidence the additional liquidity would be particularly effective in spurring new investment, accelerating consumption, or cushioning or accelerating the deleveraging that is hopefully winding down," he said.
Meanwhile, buying $500 billion in Treasuries, which equates to half of the 2011 U.S. federal deficit, could cause harm by inducing higher inflation expectations.
That could trigger inflation of 4 percent to 5 percent, and tarnish the credibility of the Fed's commitment to keeping inflation stable.
"Given the likely size of actions and the time horizon over which QE2 would be in place, inflation expectations might very well increase beyond targeted levels, soon followed by a rise in long-term Treasury rates, thereby negating one of the textbook benefits of the policy."
The Fed's independence could also be eroded by pressure to use its vast buying power to fund fiscal programs or favor particular segments of the economy, as it did when it purchased mortgage-backed securities during the financial crisis, he said.
Hoenig has dissented at every meeting of the Fed's policy-setting committee this year, opposing the U.S. central bank's promise to keep interest rates low for an extended period.
He also opposed its recent decision to reinvest maturing securities to prevent its balance sheet from shrinking, and on Tuesday said the Fed should consider reversing that policy.
Hoenig repeated his view that the Fed should move to normalize rates, removing its commitment to keeping them low for an extended period and raising them to 1 percent.
(Reporting by Ann Saphir, with reporting by Mark Felsenthal and Jason Lange; Editing by Andrew Hay)