* Plosser warns on destabilizing inflation expectations
* Plosser says worried by Fed focus on mortgage securities
By Jonathan Spicer
AVONDALE, Penn., Oct 11 The Federal Reserve's
intention to keep interest rates ultra low for nearly three more
years is suggesting to some that the Fed is willing to cut the
jobless rate at the expense of higher inflation, putting the
central bank's credibility at risk, a top Fed official said on
Charles Plosser, president of the Philadelphia Fed and one
of the most hawkish of the Fed's 19 policymakers, weighed in on
the simmering debate over just how high U.S. monetary
policymakers would allow inflation to rise in order to boost
weak economic growth and lower unemployment.
The debate has amplified - both among Fed policymakers and
outside economists - since the policy-making Federal Open Market
Committee (FOMC) last month launched a third and potentially
massive round of asset purchases and said it expected to keep
short-term borrowing costs near zero through mid-2015.
Plosser, who opposed the policy action, said in a speech
that keeping the federal funds rate so low for so long "would
risk destabilizing inflation expectations and lead to an
unwanted" rise in inflation.
"In fact, some are interpreting the FOMC's statement that we
will keep accommodation in place for a considerable time after
the recovery strengthens as an indication that the Fed is
focused on trying to lower the unemployment rate and is willing
to tolerate higher inflation to do so," he told a luncheon
hosted by the Southern Chester County Chamber of Commerce.
"This is another risk to the hard-won credibility the
institution has built up over many years, which, if lost, will
undermine economic stability," he said in his speech at a golf
club in this wealthy region of southeastern Pennsylvania.
Though U.S. unemployment fell sharply to 7.8 percent last
month, from 8.1 percent in August, analysts doubt that rate of
improvement can be sustained.
Inflation, meanwhile, has remained relatively stable near
the Fed's 2 percent target for almost three years. It is now
tracking slightly below that target.
LINES IN THE SAND
Since the Fed's latest easing move, three of Plosser's
colleagues - Chicago Fed President Charles Evans, Narayana
Kocherlakota of Minneapolis and John Williams of San Francisco -
have each specified how high above 2 percent they would allow
inflation to rise before tightening policy.
Economic theory suggests that higher inflation expectations
have the same impact as easier monetary policy: lowering
inflation-adjusted "real" interest rates, and encouraging
borrowing, investment and hiring.
"We know that monetary policy can control inflation, but its
ability to manage the unemployment rate is far more dubious,"
said Plosser, who does not have a vote this year on Fed policy.
"Chasing an elusive goal for unemployment could well risk
losing control over inflation," he added. "That was the lesson
of the Great Inflation during the 1970s."
U.S. economic growth cooled in the second quarter to a 1.3
percent annual rate, and forecasters do not think the economy is
expanding much faster now.
In part responding to this tepid growth, the Fed on Sept. 13
said it would keep buying mortgage-backed securities or other
assets until the outlook for the labor market improves
substantially, within a context of price stability.
Plosser said he, for one, interprets that to mean "so long
as the inflation outlook remains near" the 2 percent goal.
Evans, the most dovish of the Fed's policymakers, has said
he would be comfortable letting inflation run as high as 3
percent as long as the labor market was improving.
Plosser also voiced concerns over the Fed's targeting of
securities linked to the housing sector for the central bank's
third round of quantitative easing, as opposed to government
bonds, something that he said amounted to an allocation of
credit toward one sector of the economy.
That's a job better left to fiscal policymakers, Plosser
said, adding that it "endangers our independence and the
effectiveness of monetary policy."