By Jonathan Spicer
NEW YORK May 21 The U.S. economy's ability in
coming months to weather lower government spending and higher
taxes will be key to the Federal Reserve's decision whether to
reduce monetary accommodation, an influential Fed official said
In a speech that could dampen some expectations of an early
reduction in the U.S. central bank's bond buying program, New
York Fed President William Dudley said he cannot at this point
be sure whether policymakers will next reduce or increase the
amount of purchases, due to the "uncertain" economic outlook.
"But at some point, I expect to see sufficient evidence to
make me more confident about the prospect for substantial
improvement in the labor market outlook," Dudley told the Japan
Society in New York.
"At that time, in my view, it will be appropriate to reduce
the pace at which we are adding accommodation through asset
purchases," said Dudley, a close ally of Fed Chairman Bernanke
and who has a permanent vote on Fed policy.
"Over the coming months, how well the economy fights its way
through the significant fiscal drag currently in force will be
an important aspect of this judgment."
The central bank is buying $85 billion in Treasury and
mortgage bonds each month in an effort to encourage investment,
hiring and economic growth in part because the unemployment rate
remains high at 7.5 percent.
Yet with joblessness down from 8.1 percent in August, just
before the latest round of quantitative easing (QE3) was
launched, investors are anxiously predicting when the
bond-buying will be reduced or halted.
Echoing past comments by both himself and Bernanke, who will
give congressional testimony on Wednesday, Dudley said the Fed
might adjust the pace of bond purchases as the outlooks for
inflation and the labor market change "in a material way."
However he warned that investors could overreact to the
first adjustment in the pace of asset purchases, making clear
communication from the central bank all the more important.
The Fed's easy-money policy, including a promise to keep
interest rates near zero until unemployment falls to 6.5 percent
or so, has boosted bonds and stocks and any change to the policy
could shake markets.
It has also raised concerns that the central bank's swelling
balance sheet, now at some $3.3 trillion, will disrupt markets,
stoke inflation, or cause the Fed to absorb losses when the time
finally comes to reduce it to a more normal size around $1
Dudley said the Fed's policy-setting committee could adjust
its two-year old plan for reducing the balance sheet in the
years ahead, calling parts of it "stale."
"To the extent that the committee wants to reduce the risk
of disrupting market functioning during normalization, it could
decide to indicate that it will avoid selling the MBS
(mortgage-backed securities) portfolio during the early stages
of the normalization process," he said.
"Moreover, to the extent that the committee wants to
mitigate the risk of a sharp increase in long-term rates, it
could judge that it would prefer not to commit to agency MBS