NEW YORK May 4 After an extended period of
relative peace among members of the U.S. Federal Reserve's
interest rate policy-making committee, fireworks will erupt in
coming months as they debate how to reduce the central bank's
multi-trillion-dollar balance sheet, a former vice-chairman of
the central bank said on Sunday.
"The Fed may get more raucous about what to do next as
tapering draws to a close," Alan Blinder, a banking industry
consultant and economics professor at Princeton University said
in a speech to the Investment Management Consultants Association
The cacophony is likely to "rattle the markets" beginning in
late summer as traders debate how precipitously the Fed will
turn from reducing its purchases of U.S. government debt and
mortgage securities to actively selling it.
The Open Market Committee will announce its strategy in
October or December, he said, but traders will begin focusing
earlier on what will happen with rates as some members of the
rate-setting panel begin openly contradicting Fed Chair Janet
Yellen, he said.
The Fed built up its balance sheet over the last
five-and-a-half years as it bought securities to lower interest
rates in attempts to stimulate the weak economy.
But hawkish members of the Federal Open Market Committee who
worry about inflation, such as Federal Reserve Bank of Dallas
President Richard Fisher and Philadelphia Fed Bank President
Charles Plosser, are likely to call for aggressive sales and
contradict plans by Yellen and other doves in the majority who
want to keep rates low as long as unemployment continues at high
levels, Blinder told the group of stockbrokers and investment
Blinder, a supporter of Yellen who served on President Bill
Clinton's Council of Economic Advisers in the mid-90s, said the
"perils of a big balance sheet are not so horrible."
The Fed held only about $900 million on its balance sheet
before Lehman Brothers' collapse in 2008 triggered the financial
crisis, but will "never go back there" from its current level of
about $4.25 trillion, Blinder said.
A balance sheet of $1.5 to $2 trillion will likely be the
new normal, he said.
He congratulated Yellen on artfully backing away from former
Fed Chairman Ben Bernanke's assertion that rates can begin
rising once the U.S. unemployment rate hits about 6.5 percent.
The Federal Funds rate that determines short-term interest
rate will not rise anytime soon, Blinder said, noting guidance
from Yellen that she is watching several indicators of the
The housing market, consumer spending and other parts of the
U.S. economy are still recovering very slowly, said Blinder,
adding that it will be six to 12 months after the Fed completely
stops purchasing securities before rates start to rise.
He characterized the economy in this year's first quarter as
"catastrophically bad," in part because of the fierce winter.
Economists forecasting a 4 percent quarterly growth rate
this year are overly optimistic, said Blinder, who expects
growth to continue at the sluggish rate of 2.25 percent that it
has moved for the last few years.
When the Fed does begin to sell some of its securities,
rates will go up faster than they fell during its periods of
"quantitative easing," creating an overreaction from the markets
that will need to be corrected, he said.
Asked after his talk how retail investors can prepare for
the coming market volatility he is predicting, Blinder shrugged
and said, "They can't."
(Reporting By Jed Horowitz; Editing by Kim Coghill)