STOCKHOLM, May 14 (Reuters) - A hawkish Federal Reserve policymaker warned on Tuesday the U.S. central bank risks putting its hard-won credibility on the line if it fails next month to reduce its accommodative asset purchases.
Most economists do not expect the Fed to reduce its $85 billion in monthly bond buys as soon as a policy-setting meeting set for June, given the still high U.S. unemployment rate and weak inflation.
But in a speech in Sweden, Philadelphia Fed President Charles Plosser highlighted the central bank’s reputation in a fresh effort to convince his more dovish colleagues to take that first step toward tightening the extraordinarily easy policies.
“Were the FOMC to refrain from reducing the pace of its purchases in the face of this evidence of improving labor market conditions, it would undermine the credibility of the Committee’s statement that the pace of purchases will respond to economic conditions,” Plosser said of the Fed’s policy-setting Federal Open Market Committee, or FOMC.
In an effort to spur investment and boost the lumbering U.S. economic recovery from the 2007-2009 recession, the Fed is snapping up Treasury and mortgage bonds and has pledged to keep interest rates near zero until the jobless rate falls from 7.5 percent last month to 6.5 percent or so.
While Chairman Ben Bernanke and the majority of the Fed’s 19 policymakers have backed this support for the economy, Plosser and a handful of other so-called hawks worry that the central bank’s bloated balance sheet risks trouble down the road.
Plosser, who does not vote on policy this year, argued the Fed should take seriously its promise to only buy bonds until labor market conditions improve significantly - and start to taper purchases.
He pointed to improvements in the average length of unemployment, the long-term jobless, and measures of working hours and earnings as evidence it’s time to dial back the quantitative easing program, called QE3 because it is the Fed’s third such effort.
If “we become reluctant to dial back on purchases over concerns of disappointing or surprising markets, then we will find ourselves in a very difficult position going forward,” he said in prepared remarks to the Center for Business and Policy Studies and the Institute for Financial Research.
Plosser repeated he expects the U.S. economy to improve enough that QE3 should end by year end.
Investors are anxiously handicapping when the Fed will adjust the buying.
In a poll done this month, 11 of 15 U.S. primary dealers said they expect the Fed to continue QE3 into 2014, while four expect the Fed to end it late this year.
Inflation has recently dipped further below the Fed’s 2 percent target to near 1 percent, tempering expectations of a policy change this summer. And while the jobless rate has fallen to 7.5 percent from 7.8 so far this year, much of that is thanks to Americans who have given up the search for work.
Plosser also repeated he expects the unemployment rate to drop to about 7 percent by year end and to below 6.5 percent by the end of next year. He predicts about 3 percent U.S. GDP growth through 2014.