Richard Fisher

It is a world of intense competition, and that creates incentives to raise productivity as well as the means to do so. In the past decade, the U.S. economy’s average annual increase in output per hour has been 2.7 percent, just about equal to the extraordinary quarter-century boom that followed World War II. My business contacts talk and act as if the globalization now under way will bring another decade of hypercompetition. This global hothouse will enable, perhaps even force, businesses to keep productivity growth in the range we have enjoyed since the mid-1990s, hopefully for many years to come. If productivity growth can stay near 3 percent, monetary policy can accommodate relatively faster growth without igniting inflation.

Or I might fall back on the Dallas Fed ‘s tradition of poetry, which I will do now to preempt the “hawk” or “dove” question.

My Dallas predecessor
Aspired to be a dove
While others making policy
Were hawkish from above.
But this aviary naming
Invokes improper fowl
For I’d rather be remembered
As a wise, and thoughtful, owl.

We are clearly in the eighth inning of a tightening cycle.  We have the ninth inning coming up at the end of June.

Among free-trading politicians, one of my favorites is Grover Cleveland.  We don't hear too much about Cleveland anymore.

It has been suggested that borrowers, emboldened by rising house prices, are turning to nontraditional mortgages to qualify for increasingly expensive homes, setting the stage for potential repayment problems in the future. In this regard, the Federal Reserve surveyed banks on the importance of nontraditional mortgage products, such as loans with multiple payment options and interest-only mortgages. About 70 percent of those surveyed reported that such innovative products constituted less than 15 percent of the mortgages on their books. Interestingly, more than half the banks indicated that they were about as likely, or somewhat more likely, to securitize these products than traditional mortgage products. It would appear that whatever new risks may be associated with the increasing use of nontraditional mortgages are being dispersed across financial institutions and investors.

Speculative activity was also a part of the loan-officer survey [conducted by the Federal Reserve]. Over the past 12 months, more than three-fourths of the banks said that less than 10 percent of residential mortgage loans they originated went to the purchase of a second home or investment properties. At the same time, delinquency rates provide little reason for concern...Even so, we should not be overly sanguine about the housing boom and associated trends in home-mortgage lending...We will continue to keep a watchful eye for the potential dangers of stagnant or falling home prices in the future, combined with the potential for increases in mortgage payments relative to income.  

Among the American economy’s strengths are its size, diversity, interconnections and resiliency. I fully expect the economy to rebound from this disaster.

Before Katrina, the national economy was in pretty good shape, with most signs pointing to fairly strong growth. GDP had expanded by 3 percent or better for nine straight quarters. Aside from manufacturing, the job situation also looked bright...[And] despite rising prices for oil, natural gas and other energy supplies, inflation remained relatively tame...How does Katrina alter the outlook? The truth is, we do not really know.

When it comes to Katrina and the U.S. economy, my inclination is to read, listen and watch and not rush to judgment about how the disaster will impact the economy or how monetary policy ought to respond...We have a huge economy...While Katrina’s damage to Louisiana, Mississippi and Alabama is massive, the first-tier macroeconomic hit to the overall economy will be less so. We have all heard some projections for Katrina’s impact on GDP and unemployment, but I hesitate to endorse any numbers. Early estimates are notoriously unreliable.

While uncertainty surrounds Katrina’s effects on economic growth and core inflation, one thing is clear: Congress and the executive branch are acting swiftly to provide emergency funding for the affected areas. So far, the federal government has authorized more than $62 billion for recovery efforts. I have asked my staff to carefully monitor this spending. Obviously, the political authorities, not the Federal Reserve, have the power of the purse. I pray they act wisely. With the nation’s already large fiscal deficits, I personally believe it would be ill-advised for the Fed to monetize any fiscal profligacy.

We heard that the pace of economic growth had begun to slow slightly prior to Katrina and that the disruptions from Katrina, and later from Rita, would initially slow growth a bit more. The U.S. economy grew at a 3.3 percent annual rate in the second quarter. Now, most forecasters anticipate growth closer to 3 percent in the fourth quarter. Many of them expect the bounce back from rebuilding the Gulf Coast to begin in early 2006, though the impact will be spread over several years.

In this environment, the markets, if left to their own devices, would produce higher interest rates to ration money and balance the demand and supply of capital. If the Federal Reserve were to resist the upward pressure on interest rates, it would in effect monetize the burgeoning fiscal deficits. The Federal Reserve has staunchly resisted monetizing deficits for more than a quarter century, and I feel strongly that it can ill afford to monetize them today.

When governments run massive deficits, markets worry about two of three possible outcomes. The first is that taxes would eventually be raised to pay for spending...The second is that the central bank would monetize the deficit, inflating the economy. The risk would be capital flight to destinations where the purchasing power of capital is better preserved. Here, I want to make myself perfectly clear: As a member of the FOMC, I will never vote to monetize fiscal profligacy. And while I never speak for my colleagues, it is my distinct impression that none of them will do so either.

Now, the inflation rate is near the upper end of the Fed’s tolerance zone, and it shows little inclination to go in the other direction. We now face higher energy prices and businesses’ desire to pass the increased costs on to their customers. Combine the energy spikes with spending increases by governments at every level in the aftermath of the two hurricanes...and you have new demand pressures added to the old ones.

In contemplating monetary policy from this point forward, the brow begins to furrow. Most forecasters expect growth to slow from its previous pace—not so much because of the frightful destruction Hurricanes Katrina and Rita inflicted on the Gulf Coast but due to additional volatility in prices for natural gas, gasoline, certain chemicals and building supplies.

I agree that the longer-term deficit projections are daunting, even if they do not present a clear and present danger to an expansion now entering its fifth year...Left unchecked, they will become a grave danger to our prosperity and run the risk of seriously undermining the progress we have made in taming inflation.

It is the duty of the Fed to refrain from the slightest temptation to monetize deficits or embrace any other inflationary policy,  In the Volcker and Greenspan eras, the Fed has done quite well in this regard, and it can be expected to continue countering inflationary pressures should they arise.

Globalization makes it harder to sustain a Social Security system based upon intergenerational transfers.  It exposes much more rapidly and acutely the inherent limits of such policies.  If our fiscal authorities were to take this and other real world verities into account, it might just encourage better policies.  And putting our fiscal house in order before our competitors do would further enhance our edge as an investment destination, securing the future of successive generations of Americans.

Our long-term fiscal prospects may be daunting, but we do not suffer from the economic sclerosis that afflicts the Japanese and the major European powers.

The United States continues to be a preferred destination for foreign capital, the most mobile of factors.  These flows of international capital have made it easier--or at least less painful--to finance our deficits at low interest rates.  Without capital from overseas, the growth of government spending might have crowded out the growth of household spending.

Coddling inflation by monetizing deficits is not an option in a globalized world.  It would erode our currency's value and undermine our economy's potential to grow and create jobs.  The solution to the problems laid out by the participants in today's conference rests squarely in the hands of our politicians, not with the central bank.

You cannot have the dynamic progress Tom Friedman describes in his book without the well-functioning, reliable monetary regimes central banks have been sustaining. It is an especially intense responsibility for the Federal Reserve, as the primus inter pares central bank, serving the largest economy in the world and circulating the world’s most utilized currency. One cannot make monetary policy at the Federal Reserve without being cognizant of the forces of globalization acting upon our economy. Nor can one be oblivious to the need to conduct our policy with an awareness of how our actions impact markets and, therefore, economic potential worldwide. Keeping inflation in check is a central bank’s sacred mission. By spurring productivity and fomenting tectonic economic changes, globalization has acted as a tailwind for the Fed’s—and other central banks’—efforts to hold down inflation. I believe the Federal Reserve has been able to contain inflation with faster growth than would have been possible in the absence of globalization. In short, globalization has made the Fed’s job easier over the past few years.

[GDP growth] slowed to a still solid 3.5 percent in 2005, although I would not be surprised if GDP were revised upward when we take a more definitive look at the fourth quarter.

Those urging the United States to rein in its spending should be equally full-throated in prodding countries with excess savings and trade surpluses to create conditions for growing their domestic demand. If they fail to do so, and the U.S. suddenly becomes virtuous on its own, the global economy would sink into a deep funk.

It is not unreasonable to think the [housing] situation is manageable, albeit worth watching closely.

Unlike other mortgages, payments on [interest-only mortgages] increase when the interest-only term expires and borrowers are required to make principal as well as interest payments. These mortgages pack a double whammy when rates reset after the IO period expires. Many of these mortgages, however, have long periods during which the interest rate and IO period are locked up. Given that the average mortgage is held only six or seven years, many houses will be sold or refinanced before the amortization period ever kicks in.

Our economy continues to steam along at a pace that the consensus of economists estimates will be somewhere north of 4 percent in this current quarter, after netting out inflation, which we have maintained at or near the 2 percent level despite record-high energy prices.

Fisher...said he would "err on the side of being a little bit tighter rather than being a little bit looser" with US monetary policy.  The Fed, he said, should make sure "we don't let inflation rear its ugly head."

Long-term interest rates are not rising because of an increase in inflation expectations, he said, and instead indicate a "vote of confidence" in the expansion.

The fundamentals for investment are encouraging. In the high-tech area, we are still seeing declining relative prices for many products. Business sales are strong. New orders for capital equipment have been on a pronounced uptrend for 2 ½ years. The cost of capital remains favorable. Capacity utilization in manufacturing has recovered from the recession and any capital overhang is largely behind us. And business profitability is unusually high. Putting these all together, I expect investment spending to be quite robust this year. Falling relative prices should continue to support technology upgrades that enhance efficiency for many firms. In addition, rising capacity utilization rates suggest that many firms will need to add capacity to keep up with demand growth. And if I am correct, this capital spending should be enough to support overall demand in the economy, even as the housing market cools down.

Productivity growth since 2000 has averaged 3.3 percent per year, which incidentally would double average incomes in less than 21 years. This is an astonishing performance over a time period with significantly lower rates of capital formation than in the late 1990s. Thus, recent productivity gains appear to owe somewhat more to the re-organization of business processes than to the application of additional capital. But as business investment continues to grow, productivity growth is likely to be driven more by capital formation. We should therefore pay special attention to current prospects for investment spending.

The creation of vast new sources of inputs and production have upset all the calculations and equations of the very best economics minds, including those of the Federal Reserve staff. Many of the old models simply do not apply in the new real world. This is why I think so many economists have been so baffled by the length of the current business cycle as well as the non-inflationary prosperity we have enjoyed for almost two decades.

So what does the limited research on resource utilization and output gaps tell us? There are a few key, but preliminary findings from work done at the Bank for International Settlements...and some as yet unpublished work done by several of our Dallas Fed economists. Here are a few key points:
- The relationship between measures of domestic economic slack, such as industrial capacity utilization, and domestic inflation seems to have declined across a broad range of advanced countries in recent years.
- At the same time, proxies for global slack—such as unemployment rates and output gaps in a wide array of countries—seem to be of growing importance.
- And for some countries, including—and to my mind especially—the United States, the proxies for global slack have become more important predictors of changes in inflation than measures of domestic slack.

Growth is proceeding on a solid pace this year, and inflation is low and stable. Moreover, our economy has withstood several substantial shocks over the last several years, and yet has remained on course. So, I think we have abundant reason to be grateful for a quite positive economic outlook.

The conventional view of economists has long been that consumer spending is governed predominantly by a household’s assessment of their own future real income streams. Thus, despite rising energy prices and surveys last fall that suggested sagging consumer confidence, inflation-adjusted consumer spending increased at a booming 8.0 percent annual rate over the holiday season, and now runs at about 3.2 percent ahead of a year ago.  Looking ahead, to assess the outlook for consumers’ spending, you begin with their income prospects. Expectations are that the overall labor market will continue to be strong: continued job growth, a moderate unemployment rate, and further real wage gains should lead to healthy advances in incomes and, thus, overall consumer spending.

The housing market has had an amazing run in recent years...You won’t hear me use the B-word to describe this remarkable activity. Instead, I believe fundamental factors can fully explain the expansion we’ve seen in the demand for housing, particularly rising incomes, rising population, favorable tax treatment, and very low interest rates. At the present time, mortgage interest rates are not as favorable as they were a few years ago, and so it is not surprising that we are seeing some signs of a tapering off of residential activity in many markets. For example, there were 1.28 million new single-family home sales last year, but so far this year the sales rate has averaged 1.14 million. I see this not as a precipitous decline, but rather as a return to more normal conditions in many markets...Looking ahead, it seems reasonable to expect the housing market to remain strong, even as some further tapering off in sales and production takes place.  The key point I would like to emphasize is that the housing phenomenon was not a mysterious, independent boost to the economy, driven by some sort of animal spirits, but instead was a rational response by households to the economic fundamentals, especially very low real interest rates. 

Six months ago...the energy price surge had led some observers to expect to see those prices pass through to a broad range of prices of goods and services, much like what happened in the 1970s. But that hasn’t happened. Core inflation has been low and relatively steady in the last several years. Our preferred inflation measure, the price index for core personal consumption expenditures, has risen 1.8 percent over the last 12 months. Despite rising energy prices, core inflation actually fell slightly last year, since the core price index had risen 2.2 percent in 2004. Similarly, we are not seeing any sign of rising inflation in the most recent data.

I believe globalization and monetary policy are intertwined in a complex narrative that is only beginning to unfold...The realization of the importance of global economic conditions for making monetary policy decisions is becoming more widespread. 

In the presence of a productivity surge, the Fed should not tighten but should instead let the economy enjoy the ride without fearing a rise in inflationary pressures.

The econometric calculations behind the Phillips curve, capacity constraints and output gaps were based on assumptions of a world that, in my opinion, no longer exists.

Protectionism is nothing but a tax on the consumer and the businesses that use foreign inputs. Every protectionist impulse, however politically advantageous for a particular political jurisdiction or an individual industry, undercuts globalization’s favorable impact on inflation. Protectionism could lead to interest rates higher than otherwise required to maintain low inflation.

We are concerned about prices. We see pricing power creeping upward in the reports we’re getting from the CEOs. As you know, our compass in Dallas is the trimmed mean PCE. It’s running at a rate of about 2.3 percent. At some point in the future, Mr. Chairman, I would like to provide a memo on that particular measure of inflation, which we consider to be a more reliable indicator of future inflation. But the point is that, in all of our soundings among these operators of businesses, they are feeling increasing price pressure, both at the intermediate level and at the consumer level. There are two little indicators that I found interesting. One is that Texas Instruments, which usually has 200 or 300 jobs maximum outstanding and looks for highly trained engineers, is now trying to fill 1,000 of those jobs and having trouble filling them. Second, at the other end of the range, 7-Eleven reports that in Florida, the Great Lakes District, and the Chesapeake Bay area, they cannot find $7- to $8-an-hour sales clerks. They are having to raise their prices.
In short, we view this economy to be something like a 2006 BMW Z4 Roadster—Bluetooth-enabled, by the way. It’s complex, it’s highly integrated, it’s a technically advanced machine that apparently cannot help itself from exceeding the speed limit. [Laughter] Thank you.

Without the contribution of the global workforce, moreover, the quantity and variety of goods and services available in the United States would diminish. I have argued, within the temple of the Fed and without, that globalization has in these and many other ways expanded our concept of “capacity constraints” and redefined our sense of “resource utilization.” It has helped tame inflation. That has been the trend of recent years. But it has not exorcised for once and for all time the demon of inflation.

Of late, the Trimmed-Mean PCE Deflator has been running at a rate of 2.4 percent, about 30 basis points higher than the PCE ex-energy and food. A compounding of 2.4 percent over a decade cuts the purchasing power of a dollar to 79 cents. Of course, it is reckless to extrapolate historical numbers. But this 2.4 percent rate is disarmingly close to one of the market’s key indicators of inflationary expectations—the spread between rates paid on Treasury Inflation-Protected Securities, or TIPS, and ordinary Treasury bonds of 10-year maturity

Over a decade, 3.2 percent yearly would reduce the value of a dollar to 73 cents. To me, this is more than discomforting. It is unacceptable.

I expect second-quarter GDP growth to be revised upward to closer to 3 percent. And my best guess one month and two weeks into the third quarter is that the speed at which we are now proceeding is roughly of that magnitude. From my vantage point, despite what you hear from some of the Eeyores in the analytical community, a recession is not visible on the horizon.

Let me assure you that there are no hawks and there are no doves on the committee. I see only owls: 19 men and women who are doing their level best to devise a wise and considered policy aimed at fulfilling the Fed’s dual mandate of providing the monetary conditions that foster sustainable, non-inflationary growth.

As I sit at the FOMC table, I continue to fret more about inflation than I do about growth. While I am well aware of the risks to economic growth, the history of inverted yield curves, and the ever present possibility of exogenous shocks in a politically hazardous world, the “balance of risk,” in my book, is still tilted to the inflation side of the equation.

The FOMC left its monetary target—the fed funds rate—unchanged last week at 5.25 percent. I accept that decision. While the inflation risk I have just elucidated is very much on my mind, it is my considered judgment that the recent tempering of U.S. economic growth to a more sustainable rate, combined with the lagged effects of our 17 prior quarter-point rate increases, should act to lower the inflation rate over time. However, if this proves not to be the case, appropriate action will have to be taken.

Indulge me for a moment here. Let’s suppose that this substantial economic machine we know as Texas changed its relationship to the U.S. in one and only one way: by establishing its own free-floating currency and independent central bank with the same mission as the Fed—except just for Texas. I know what some of you are thinking: The loonie is already spoken for, so let’s call our imaginary Texas currency the “burrito” and back it with the full faith and credit of the government in Austin, a government, incidentally, that is currently running a budget surplus.

You know this viscerally here in England: Your forebears launched the Industrial Revolution and invented the locomotive, one of the most creatively destructive forces — short of Margaret Thatcher — that the world has ever known. You have lived with capitalism’s constant change longer than any other people. Creative destruction is part of your national DNA, just as it is part of ours in the United States.

MR. FISHER: It struck me particularly yesterday that we are not hearing anything about pricing power at this table. That was our preoccupation for a while. Not one person at the table mentioned it in the way it had been mentioned in the past several conversations. We are, however, continuing to hear about the availability and the cost of labor, and some of those costs, incidentally—such as the welders and Governor Kroszner’s show-up premium—are not going to be reflected in the data.
The bottom line is that I think we’ve made substantial progress. But I think we have to be very mindful, Mr. Chairman, about perception if we’re to influence what really counts, which is inflationary expectations, and about whether those expectations are measured accurately by TIPS spreads, which I personally doubt. One need look no further than this morning’s Financial Times editorial or Bill Gross’s recent client letter—I’ve known Gross for twenty years, and I know he’s an oddball. Actually, I’d like that word struck from the record. [Laughter]
MR. MOSKOW. What do you want to substitute? [Laughter]
MR. FISHER. He’s increasingly addled, but his words do carry weight. In his recent client letter, he says, “Inflation is leveling off at admittedly unacceptable levels.” Hence my careful reference to the word “comportment.” I think first about the immediate statement, and I want to come to that.

I'm encouraged on the inflation front.  You see it in the CPI, you see it in the PCE (personal consumption expenditures price index), ex-food, ex-energy.  You see it now in the trimmed mean (PCE).

From an interview with Reuters News

It is a very early stage of the discussion and at this stage I wouldn't read into that [inflation targeting] is inevitable.  I am undecided on this.  I am still studying it...  It should take a while to work through because it is not something you do willy-nilly, it's something you do with great deliberation.

From an interview with Reuters News

"We're flying at a less than optimal altitude in terms of the speed of the economy ... and the good news is that ... some inflationary pressure has been released," Fisher told Reuters in an interview.

"I'ld like to see us gain a little more altitude.  But I'm very comfortable with where we are right now in terms of monetary policy."

From an interview with Reuters News

 

 

First the good news: It is possible that the trend in overall consumer inflation has peaked and is finally heading lower. Next, the not-so-good news: The overall inflation trend remains at a level above my comfort zone. I am encouraged by the change in direction of trend inflation, and I hope that in the future my CEO and CFO contacts will be telling me that the competitive forces of globalization have kept their pricing power limited or nonexistent.

Each month, as I prepare for an FOMC meeting, I spend a great deal of time talking with CEOs and CFOs of companies to gather their impressions of the current state of the economy. To prepare for this last FOMC meeting, for example, I spoke to the leaders of companies whose annual revenues aggregated to a little over $1 trillion and whose operating income easily exceeded $110 billion last year. In these monthly interviews, I ask about activity and trends in their businesses and what they see happening with their production lines, customer bases and competitors in hopes of gaining insight into current growth and inflation dynamics in the economy. Recognizing the limits and risks of anecdotal evidence, even coming from the most disciplined and experienced corporate operators, I personally find this an effective way to bridge the gap between what our economic models tell us—based as they are upon historical data and various theoretical assumptions about the future—and what is happening in the real economy.

A good central banker knows how costly imperfect data can be for the economy. This is especially true of inflation data. In late 2002 and early 2003, for example, core PCE measurements were indicating inflation rates that were crossing below the 1 percent "lower boundary." At the time, the economy was expanding in fits and starts. Given the incidence of negative shocks during the prior two years, the Fed was worried about the economy's ability to withstand another one. Determined to get growth going in this potentially deflationary environment, the FOMC adopted an easy policy and promised to keep rates low. A couple of years later, however, after the inflation numbers had undergone a few revisions, we learned that inflation had actually been a half point higher than first thought.

In retrospect, the real fed funds rate turned out to be lower than what was deemed appropriate at the time and was held lower longer that it should have been. In this case, poor data led to a policy action that amplified speculative activity in the housing and other markets. Today, as anybody not from the former planet of Pluto knows, the housing market is undergoing a substantial correction and inflicting real costs to millions of homeowners across the country. It is complicating the task of achieving our monetary objective of creating the conditions for sustainable non-inflationary growth.

I would argue that international data deserve closer examination in order to understand the influences an integrated global economy has on our economy and our currency and the implications of that integration for our monetary policymaking.

"We live in a country with enormous economic production."  Fisher said at the Texas Lyceum Public Conference in San Antonio.  ``We produce over $13 trillion a year in output.  We have 300 million mouths to feed, 140 million workers, and we are growing forcefully.''

As reported by Bloomberg News

The dollar is widely used as a transactions medium, as an invoicing currency and as a currency of issuance for international bonds. The euro has made some inroads in all of these areas—not least as a transactions medium, where the existence of €500 notes has enhanced the currency’s attractiveness relative to the dollar in the cash economy—but at nowhere near the pace that some analysts had predicted prior to the currency’s launch. I would expect the euro to continue to grow in importance as an international currency in coming years.

Richard Fisher urged Germany to ``seize the mantle of leadership'' in the European Union from France and set the pace in making the region's economy more flexible.
     ``It seems to me that the bureaucratization of Europe by France has hindered progress,'' Fisher told an audience in Berlin, stressing he was speaking in a personal capacity. ``There is a need for German leadership.''

As reported by Bloomberg News

"I'm comfortable presently with where we are."

...

Fisher said that inflation is "stickier" when slowing down than when it's acclerating and that "one month does not make a trend."

As reported by Bloomberg News

On the inflation front, the good news is inflationary pressures appear to have reached a stasis, despite the labor shortages in certain sectors -- particularly in chemicals and petroleum industries and in functions requiring skilled and semiskilled workers. The bad news is that the stasis is at too high a level for party poopers like me who will have no choice but to advocate tightening monetary policy further if inflation does not ratchet downward.

Given all of this, I would have to say that the risk of unacceptably high inflation still outweighs the risk of substandard economic growth

I do not agree with pundits who argue about whether we can engineer a “soft landing.”  “Landing” implies stopping. I prefer to say that the Fed’s job is to provide the monetary conditions necessary to pilot our economy at a comfortable cruising altitude and speed while preventing the engine from overheating with inflation. As we look to 2007, I consider this objective to be within reach.

This is all just a long-winded way of saying that it is difficult to say with true precision just how the economy will close out this year in terms of growth and pace. My guess is that we are most likely going to finish the year at a pace that exceeds the gloomy forecasts making all the headlines lately. If you net the downdrafts from the housing and auto sectors against the tailwinds from other countries that are growing faster than the United States, then adjust for the updrafts of a dynamic service sector and thank your lucky stars for a warm start to winter and burgeoning oil and gas inventories that have softened energy prices, I wouldn’t be surprised if the economy proves to have grown at better than two percent, net of inflation, in the second half of this year, then picks up pace in 2007. This is not a forecast, mind you. There are risks out there that, should they come to pass, would result in slower growth. Barring any unforeseen circumstances, however, I think this is a reasonable expectation. At least, that’s how I see it from my perch at the Dallas Fed.

On the bond market's expectations for lower rates in 2007:

``Our job is not to satisfy markets. Our job is to get the economy right.''

From Q&A session, as reported by Bloomberg News

We have a pretty good cruising speed currently... We have seen some very encouraging news {about inflation}...  I am very comfortable with where we are now in terms of our policy. 

From a Bloomberg TV interview.

At this early juncture in 2007, I think it entirely reasonable to expect the economy to maintain an average pace of 3 percent growth for the year. And, if we at the Fed do our job well, we should be able to accommodate that growth rate while bringing inflation down below 2 percent

I wouldn’t rule out further increases in the federal funds rate if inflationary winds gain the upper hand. Indeed, if increases are needed, I would aggressively advocate for them. But for now, I am as comfortable with the inflationary outlook as a prudent central banker can be. No central banker can ever be smug about containing the risk of inflation, but I am pleased with the current direction of inflationary impulses.

It wasn’t too long ago that the markets were fretting about underfunded liabilities of pension plans. Recent equity market rallies around the world have mitigated that risk. Pension fund managers now have ample opportunities to secure some of their long-term funding needs in the higher quality tranches of the bond market. The 30-year Treasury bond yields 4.84 percent. If my math is right, this means someone can buy so-called stripped bonds that mature in 2037 at $100 for 25 cents on the dollar, thus matching every dollar of their long-term liabilities for a quarter. Of course, prudent fund managers would only do that if they were confident that the Fed would continue to protect the purchasing power of those strips. If we continue to contain inflation, they will—strengthening the financial security of American workers.

That hits the nail on the head. That, and remembering you never, my friends, never, never, never, go deer hunting with an accordion.

Clearly, if I were to be asked which I have more concern about, it would be there are still risks to the upside. In the distribution curve, there is a tail that is a little bit fatter in terms of risks to the upside on inflation.  if we conduct the right policy, we can bring inflation and have inflation this year at or below 2 percent. But we'll see.

...I don't think my views have changed. I expect we will be growing around 3 percent this year. I believe we can do that, and with the right policy, we can bring inflation down below the 2 percent level.  I don't see a recession staring us in the face, if that is the question.  My views haven't changed very much since I  spoke about this before Christmas.'

From the audience Q&A session, as reported by Bloomberg News

I assure you that those of us who have the privilege of providing conflicting counsel at the FOMC table, including yours truly, have no desire to keep our economy at the crossroads. Day in, day out, we strive to keep it moving, faithful to our dual mandate, so that we might engender prosperity both for Texas and for the nation.

The subprime situation may well be a blessing in disguise.  It reminds us that history does have the capacity to repeat itself.  The old financial axioms — levelheaded notions such as “know your customer” (or your counterparty) and “there is a difference between price and value” — remain valid.  I expect market discipline to reassert itself, swiftly punishing those who pressed the limits of imprudence or suffered selective amnesia, hopefully doing so in a way that staves off the impulse for lawmakers and regulators to interfere disproportionately. 

We're accustomed to finding the roots of inflation in too much money chasing too few goods. For too long, however, we've brushed aside the issue of whose goods. Just our own? At one time, maybe -- but not in today's globalized economy.

In teaching inflation's causes and cures, economics professors have for generations invoked the famous Equation of Exchange. With mathematical clarity, it tells us that prices are directly linked to the amount of money in circulation and the speed at which we spend it. So print money faster than the economy grows and the value of a dollar will fall.

Luckily, transaction velocity remains relatively stable over the years, allowing us to conclude that inflation mainly depends on money growth, an instrument of policy, and the pace of economic expansion.

...

But we're now in an age of globalization. Freer movement of goods, services, people and ideas stretches production to the far reaches of the planet. China, India and other newcomers with huge labor resources and productive capacity are becoming important players. Each year, the part of our economy isolated from global competition becomes smaller.

It seems unlikely that inflation would remain a purely domestic affair in our globalizing economy. Research by a handful of economists like Harvard's Ken Rogoff has found important links between foreign production and U.S. inflation. The empirical studies are changing some minds on the subject of globalization and inflation, but we also need new doctrine -- an equation of exchange for the new economy.

"We have a responsibility to make sure inflation does not get out of the bag," Fisher told attendees at a luncheon held by the Dallas Fed in McAllen, Texas. "I am among those ... that believe we still have some more work to do on that front," Fisher said.

...

He said of the U.S. economy, "I believe that we will continue to grow, and the pace of growth will pick up as we go through the year."

In his remarks to the audience, Fisher said that a measure of inflation produced by the Dallas Fed, the trimmed mean personal consumption expenditure rate, remains too high for his taste.

As reported by Dow Jones news

The common thread among these 10 factors is that they all raise productivity’s level or its growth rate—or both.  Higher productivity lowers costs.  Lower costs restrain inflation, the bête noire of any progressive economy and the bane of Federal Reserve officials and central bankers everywhere.  In this fundamental way, globalization raises the economy’s speed limit, allowing policymakers to relax a little and let the economy expand at rates that might once have been considered unsustainable.  In a globalized world, faster growth need not carry the same inflationary implications it does in a closed world.  

History may place blame on this or that president or on Congress for failing to act.  But, ultimately, the responsibility to solve these looming fiscal issues rests with voters.  In the end, the person who is responsible for the $83.9 trillion meltdown that is happening before our very eyes—the person responsible for saddling each of your children and every other person you love with $280,000 in debt—is the one you look at in the mirror each morning.   

Data revisions have important implications for policymaking and policy evaluation.  Potentially, they can erode central bank credibility.  Partly because of data revisions, it is hard for us to spot turning points in the economy.  The fact is, statistical agencies fill in missing data with extrapolations that are especially likely to be wrong at these turning points because the estimates and probabilities they use are biased toward the latest trend.  The result is that we are likely to underestimate slowdowns and pickups at precisely the moment when we need to take corrective action.  

"We can't take our eye off the ball" on inflation. "I'm uncomfortable with inflation running about 2 percent," referring to the core price index for personal consumption expenditures.

As reported by Reuters

We're always making judgments depending on what we're seeing, smelling, hearing, and feeling in the economy, and seeing in the data.  I'm happy with policy at present.

This evening, I have done my best to explain that true success comes to those who best put their talents in context and who connect a substantial intellect to an equally developed emotional capacity. Those of us who lead cerebral lives must constantly strive to elevate our “people skills” to a level equal to our intellectual skills.

I continue to expect that the economy is not as weak as some of the negative pundits would view it.

As reported by Reuters News

Except the housing sector, I would expect economic growth to pick up.  We are a powerful economic machine.  We continue to grow.

As reported by Bloomberg News

As globalization continues and the world economy evolves, more creative destruction will impact your states. That is the bad news because job destruction creates political pressures for transition programs at best and protectionist or retaliatory responses at worst. The good news is that the creative side of this inexorable phenomenon, properly managed, results in better jobs, higher living standards, lower prices and increased prosperity.

My guess is that a great deal of the potential dislocation resulting from corrective reactions to the subprime boom will be resolved by regulatory initiatives rather than by monetary policy...

Any new regulations that might now be crafted to prevent future recurrences must be well thought out, for two reasons. First, financial institutions will quickly adapt to defeat any regulation that is poorly designed, morphing into new, vaccine-resistant strains. Second, heavy-handed regulations are sometimes worse than the disease against which they are meant to protect. I would be wary of any regulatory initiatives that interfere with market discipline and attempts to protect risk takers from the consequences of bad decisions for fear of creating a moral hazard that might endanger the long-term health of our economic and financial system simply to provide momentary relief.  

To live up to what is expected of us, we have to make considered judgments and not react to the latest data point or the "instant analysis" that is ubiquitous on the Internet or in the news media or among the countless financial analysts who pump out commentary like water from a fire hydrant.

As we sat down to the FOMC table on Tuesday, we were faced with a situation that, drawing on my Naval Academy days, I would liken to a ship navigating a narrow passage between two shorelines. ... If we had maintained the anti-inflationary course we had been following for more than 14 months by holding the fed funds rate at 5.25 percent, I believe we would have risked oversteering our course and potentially run afoul of the shoals of unacceptably slow economic growth.  

 I am guessing, however, that you, being in the real estate business, probably know that last Tuesday the Federal Open Market Committee (FOMC) held a meeting and decided to cut the federal funds rate by one-half of 1 percent, an event that seems to have given rise to almost—but not quite—as much chatter as recent developments affecting the sports memorabilia collection of O.J. Simpson.    

Today, we central bankers are grappling with globalization—the freer flow of goods, services, money, ideas and people across national borders. Its present incarnation owes a great deal to the revolution in information technology. Faster, cheaper and better communications are breaking down barriers to international business and knitting the world's economies closer together faster than the New York Mets can blow a pennant race. 

``There are still issues with regard to asset-backed commercial paper,'' said Fisher, who doesn't vote on rates this year. ``It's the not the Federal Reserve's job to engineer asset prices. Our job is to keep the economy growing at a sustainable rate of growth without incurring inflation. That's what guides us in our discussions at the table.''

From the Q&A session, as reported by Bloomberg News

The economy "probably had decent growth" in the third quarter of "three percent-plus," he said. He said it's "too early to tell" about the fourth quarter but said, "I expect growth to slow" in part because of consumer and business caution.

As for the first quarter of next year, Fisher said, "we'll have to see how the economy's recuperative powers are."

From Q&A session, as reported by Market News International

[H]igher oil prices caused by productivity gains have a much different effect on the economy than oil supply shocks. A productivity shock originating in the U.S. will boost our economic output, and the expansion will pull up the price of oil. If monetary policy holds the growth of nominal GDP constant, this will result in a reduction of inflationary pressures. If China or India or some other country is expanding rapidly and it is the country's oil consumption that is increasing, driving up prices, that surge in productivity can yield spillovers for the U.S. in the form of lower import prices and technological gains. As long as this continues, we can expect to see an expansion of output and lower overall prices, even as the world price of oil rises. A vicious cycle is, in a sense, almost transformed into a virtuous cycle.

With each uptick in energy prices, I ask whether it is supply or demand that is making prices rise. Supply disruptions are cause for concern, but growth in demand is not as worrisome. Most likely, energy prices will continue to be volatile; it is the nature of the beast. The same goes for food prices.

Those of us responsible for crafting U.S. monetary policy cannot afford to be distracted by the flux of short-term price changes that are destined to be unwound. Our eye should be focused on underlying inflationary pressures, some of which may indeed be coming from food and energy markets. Routinely excluding food and oil price movements from our inflation gauges may have made sense in the 1970s, the 1980s and even the 1990s—but not now, nor in the next few years. The conceptual beauty of trimmed mean inflation measures lies in their ability to capture steady increases in food and energy prices, which may be germane to the pursuit of price stability, while excluding the temporary spikes and dips that do not presage changes in the underlying inflation rate. 

We have a way to go before full recovery and must acknowledge that shocks and accidents might happen. Phrasing it politely, as an Aussie-Texan, I suspect some real "cow patties" remain in some prominent institutional punchbowls in the U.S. and abroad, and they will undoubtedly come to light before too long. I would submit, however, that we are on our way back to markets priced by reason rather than fantasy and that systemic risk has been lessened substantially.

Increasingly, globalization is blurring economic boundaries. On the inflation front, for example, we have extensive economic playbooks that tell us how to treat the wage–price spiral or cost-push forces in a closed economy. In a closed environment, one would ordinarily expect that a weakening economy would lead, in turn, to a diminution in price pressures. But we have less experience with prescribing policy in an open economy where demand-pull forces come from beyond our borders—such as the burgeoning demand for commodities and food from rapidly growing and newly consequential economies like China, India, Latin America and the countries liberated from the oppression of Soviet communism. These faraway places play an ever-increasing role in determining prices here at home.

In my view, the degree of substantive action to support economic growth and insure against downside risk will be conditioned by what we see coming down the inflation pike. To deliver on its dual mandate, the Fed must keep one ear cocked toward signs that inflationary expectations are drifting upward as we execute additional monetary measures. 

...

The challenge to monetary policy, as I see it, is to achieve the growth part of our mandate in the short term and get “ahead of the curve” without shaking faith in the currency over the long term.

I mentioned single malt whiskey earlier to describe the effective time lags of monetary policy. I realize it is only lunchtime, but let’s return to the economics liquor cabinet for a moment. Inflation is like absinthe. The narcotic allure of inflation is a dangerous thing. It might seem like the remedy to bail out a government or a bad book of business and forget your troubles. Yet our experience in the past has taught us only too well that inflation is a dangerous elixir that ultimately proves debilitating for businesses, consumers, investors—including those foreign investors who have lately come to the aid of some large balance sheets here—and especially for the poor, the elderly and people on fixed incomes. It even inculcates bad financial behavioral patterns in the young by encouraging spending rather than investment and saving. Inflation is bad for Main Street and Wall Street and even for Sesame Street.

Monetary policy acts with a lag. I liken it to a good single malt whiskey or perhaps truly great tequila: It takes time before you feel its full effect. The Fed has to be very careful now to add just the right amount of stimulus to the punchbowl without mixing in the potential to juice up inflation once the effect of the new punch kicks in.

We have been hard at work trying to find the right mixture.

We have some glaring examples today of the destruction that can be wrought by governments with direct control over monetary policy. Zimbabwe is the most egregious. A year ago, after having let monetary printing presses run wild to cover up problems created by misgovernment, President Mugabe famously declared inflation illegal, promising to arrest and punish anyone who raised prices or wages. Of course, that didn’t work. Just last week it was announced that Zimbabwe’s inflation reached 26,470 percent in November. The economy of Zimbabwe has been destroyed and its people cast further into poverty as their savings disappear.

My dissenting vote last week was simply a difference of opinion about how far and how fast we might re-spike the monetary punchbowl. Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time to support additional monetary accommodation.

I respect the majority view of the committee. I sleep well at night knowing that the collective wisdom of the group is guided by one common goal: the continued prosperity of the American people.

For the past few years, we have had a raucous party of economic growth fueled by an intoxicating brew of credit market practices that financed a housing boom of historic, and late in the cycle, hysteric, proportions. With the benefit of perfect hindsight, some have argued that the Fed failed to take away the punchbowl as the subprime party spun out of control, leaving rates too low for too long and not using our regulatory powers to restrain excessive complacency in the pricing and monitoring of risk. But that is beside the point.

Now we are faced with the consequences of a process that lawyers would call the “discovery phase”: As big banks and other financial agents confess their acts of fiduciary omission and excesses of commission, credit markets have effectively de-leveraged important segments of the economy, slowing growth suddenly and precipitously. Instead of taking the punchbowl away, the Federal Reserve is now faced with the task of replenishing the punch.

We have to be wary of the fact that we are navigating through an extremely narrow passageway here: with on the one side of us inflationary shoals and on the other the risk of weaker economic growth.

As reported by Reuters

Being a dissenter -- it's not like in politics where it's some awful negative thing. All of us are responsible and take very seriously the duties of inflation management.

From press Q&A as reported by Market News International.

Right now we have a weak economy ... Yes, there is a lowering of expectations for growth but it is positive economic growth. And the forecast calls for the economy to start picking up pace as we go through the second half of this year.

From press Q&A as reported by Market News International

The Term Auction Facility is a useful new part of the Fed's tool kit that should stick around as long as it's needed, he said.

"I do think it had a psychological impact. I also think it had a real impact," Fisher said. "It more specifically addresses the hardening of the arteries in the cardiovascular system of money, as opposed to being a tool to be used for the purposes that we use federal funds rate for."

From press Q&A as reported by Market News International

What you're seeing is more and more reports and discussion about inflation ... Women and men that run businesses are reading those and they are beginning to think in their own brains, in terms of positioning their companies, how they deal with what is suddenly becoming more and more of a noticeable issue.

From press Q&A, as reported by Market News International

We have to be mindful of that fact that we have to create the conditions for employment growth, at the same time be careful that we don't stir the embers of inflation.

As reported by Reuters.

The Federal Reserve Board candidates awaiting Senate approval are ``highly unlikely'' to be confirmed by the legislature before a new president is elected this year, Dallas Fed Bank President Richard Fisher said.

``Whether or not that gets done before the political election is for you to guess...  The answer is highly unlikely.''

As reported by Bloomberg News

As for the municipal bonds, Fisher said that market's woes do not appear to be having a significant liquidity impact on corporate financing. So far, corporate treasurers and cash managers aren't overly dependent on those instruments in their portfolio, he said. But it's a different story for the muni market itself.

"There's a short-term impact. I think the long-term impact of that will be mitigated by new financing methods that'll be discovered by issuers," Fisher said.

From press Q&A as reported by Market News International

In discussing his  2005 "eighth inning" remark to CNBC.

"The lesson learned there was first of all, never go on television," he said. "But more importantly, Federal Reserve officials have to be more circumspect. People pay attention to what we say."

It's no question that in a globalized economy, whereas before we were the beneficiary of tailwinds that helped us with new labor supply feeding into our productivity here in the United States, now we're facing headwinds based on demand-pull inflationary forces with these 3 billion plus new consumers around the world. So I'm more concerned about inflation than I have been of late. It's a growing concern.

The economy is clearly anemic. We're going to have a period of substandard growth that'll stretch for a couple of quarters, if not a little bit longer. At the same time, we do have worse numbers than we had before on the inflationary front. It's always dangerous in this business to do what I think is an oxymoronic thing which is instant analysis. You have to really study the entrails of all the new numbers that have come through. I think it's too soon to form a judgment as to whether the economy is indeed weaker than I expected or inflation pressures are worse than I expected. But clearly the numbers that have come through indicate that we're in for a period of prolonged, slow, economic growth

We see it in particularly in commodities, and energy products. Those are usually taken out in core inflation measurements. However in Dallas, at the Dallas Fed, we don't use a core measurement. We use a trimmed mean measurement and even on that basis we see inflationary levels rising.

I believe there're longer term tectonic, structural forces at play. If they were temporary I'd be less concerned about them. I'm more concerned because I think they have to do with demand-pull as I mentioned earlier coming from the world at large as it grows and the ability of supply to respond. I'm concerned also by the way that the futures markets for oils have not proven to be very good indicators of future oil prices. So if we have these sustained high price levels... if gasoline at the tank goes as it has up 8 cents two weeks ago, 9 cents this past week and keeps rising, no doubt it will feed into inflationary expectations of consumers, and then business women and men who run businesses, and that's what we have to guard against.

We like these buzzwords recession and stagflation. I don't think that's the issue. The issue is how can we conduct monetary policy and use the tool kits that we have in order to provide the conditions for sustainable, non-inflationary growth. That's what our hearts are set on. That's what our minds are devoted to. That's what we're trying to achieve.

[T]he FOMC must be careful to not undermine that recuperative process. Here, of course, I refer to the potential harm to the consumer and the business and financial sectors alike by unwittingly allowing the perception to take hold that, as the New York Times editorialized in its lead front page article last Thursday, “the Federal Reserve, signaled [its] readiness … to bolster the economy with cheaper money even though inflation is picking up speed.”[2]

Talk of “cheap money” makes my skin crawl. The words imply a debased currency and inflation and the harsh medicine that inevitably must be administered to purge it. So you should not be surprised that I consider the perception that the Fed is pursuing a cheap-money strategy, should it take root, to be a paramount risk to the long-term welfare of the U.S. economy.

I believe the Times overstates its case. Chairman Bernanke made clear in his congressional testimony last week that we are monitoring inflationary pressures and expectations closely. And yet, I understand the source of the Times’ sentiment.

The TAF has been successful. ... We will continue using that tool for quite a while, as long as is necessary.

From Q&A as reported by Reuters and Market News International. He also described the federal funds rate as a "blunt tool."

Fisher said that FX markets are "manic-depressive mechanisms".

"The mood comes and goes," Fisher said, noting that the days of the vvery weak euro exchange rate against the dollar were not so long ago. Fisher said that central bankers should not react to short-term movements in exchange rates.

From Q&A as reported by Market News International

The point is that, at present, we simply do not have the ability to adequately account for the impact globalization has on the gearing of our domestic economy. Absent that capacity, we cannot, in my opinion, confidently assume that slower U.S. economic growth will quell U.S. inflation and, more important, keep inflationary expectations anchored. Containing inflation is the purpose of the ship I crew for, and if a temporary economic slowdown is what we must endure while we achieve that purpose, then it is, in my opinion, a burden we must bear, however politically inconvenient.

To some, this may appear a Hobson’s choice. I don’t see it that way. Our obligation is to prevent inflation in order to sustain long-term employment growth. I believe that the best way to cut through the treacherous economic waves that are upon us and keep our ship steaming forward is to stick to our purpose. 

Globalization also should make us change the way we interpret some of the indicators that have traditionally played such an important role in monetary policy deliberations. Globalization indeed warrants the examination of a broader array of data in arriving at monetary policy decisions. For example, understanding global capacity utilization in an industry may be more useful than equivalent measures of domestic capacity.

[G]lobalization does not undermine the ability of the Fed, or any other central bank for that matter, to control inflation over an appropriate time horizon, but it does challenge us—you might say it disciplines us—to conduct monetary policy more prudently. In today’s world, where investors can move their funds instantly from one currency to another to avoid depreciation, the price central bankers pay for high inflation is much higher than in the past. Understanding this, you can see why I am a steadfast inflation-fighting owl.

Globalization does matter for inflation, but not in the ways that are often suggested in the media. The most common fallacy is, of course, the confusion of relative price with price level changes, the idea that a flood of cheap imports from China must of necessity lower the price level and the inflation rate. The channels whereby globalization affects inflation are much more subtle and not always necessarily benign. Furthermore, I believe that different dimensions of globalization affect the dynamics of inflation in fundamentally different ways.

Let’s start with trade. The availability of cheap imports from China and other countries does have a direct and indirect impact on domestic prices and inflation. There has been a significant amount of work in recent years trying to document the size of this effect. The estimates vary, but they are generally significant. But the mechanism whereby the price changes are realized is subtle.

The thirst of the emerging-market economies for raw materials and the relative inefficiency with which they use these raw materials has propelled industrial commodity prices to record levels. The fact that these increases have been persistent and not quickly reversed has raised tough questions about traditional measures of core inflation and made it increasingly difficult for central bankers to separate signal from noise in the inflation data.

The fourth dimension is the least understood. That is the global assignment of tasks through nontraditional channels. The U.S. is a high-value-added, services-driven economy; services represent over 80 percent of our economy. The growth of service sector trade, particularly through fiber optic cable and satellite connections, poses significant measurement issues. It is not as if we can just go down to the docks and count containers coming and going to quantify the impact of service sector trade. And what implication does the increasing trade in tasks with cheap labor pools around the globe pose for pricing of services and, in turn, for inflation?

The thirst of the emerging-market economies for raw materials and the relative inefficiency with which they use these raw materials has propelled industrial commodity prices to record levels. The fact that these increases have been persistent and not quickly reversed has raised tough questions about traditional measures of core inflation and made it increasingly difficult for central bankers to separate signal from noise in the inflation data.   

I think it is very important ... for central bankers to do their best in keeping a steady hand under emergency circumstance. I am not saying this is an emergency circumstance but when things are volatile, it's important that central bankers be deliberate.

As reported by Market News International

I would discourage you from thinking that simply because, or because of, significant action in credit markets like we had yesterday, that suddenly we are going to have an Open Market Committee meeting and that suddenly we are going to move Fed funds rates in response.

We reacted with very deliberate actions that took place ... in a very short period of timeframe, and I think that it shouldn't be the markets' expectation that we will continue to react in that manner.

As reported by Reuters.

Fisher said he disagreed with the view the Fed had been "pandering" to markets in cutting rates aggressively.

"We took the actions that were taken as a group in response to what we viewed as the prospective weakening of the US economy and were driven by economic considerations. In terms of the actions we take on the Fed Funds rate there are other tools we can use, for example the term auction facility addresses liquidity needs, and we will continue to develop our tool box," he said.

"My sense, from my personal perspective, is that 3.5% was a sufficient level. We have moved very quickly to that level. Going further to 3% might create a bit of a counter-reaction. In fact, it did create a bit of a counter reaction - that is long term rates went up including on jumbo mortgages and, of course, the dollar has weakened," he said [when asked about his January dissent].
...
"I trust in the wisdom of my colleagues."

As reported by Market News International

The Federal Reserve has taken a very pro-active stance in response to what we view as economic developments. We have other tools to work in terms of market liquidity, the term auction facility, for example ...

I would discourage you from thinking that simply because, or because of, significant action in the credit market like we had yesterday that suddenly we are going to have a meeting of the Open Market Committee ... and that suddenly we are going to move Fed Funds rates. It doesn't work that way.

As reported by Market News International

If we again begin to grow, at a time when inflation is still at a very high base level, then we could (create) conditions for sustainable inflation over the long term.

...

Consumer price inflation is rising, and the personal consumption expenditure basket is rising to uncomfortable levels. ... What we are trying to do ... is condition expectations of where we go, going forward, to make sure that inflation doesn't get out of control. Because we know that there is a lag in monetary policy

As reported by Reuters

The priority focus should be figuring out new ways to enhance liquidity, reduce the fear that people have as counter-party risk
...
We recently opened up our window to lend to what are called primary dealers. I fully expect that in return for that we will get regulatory authority to actually oversee those dealers, to make sure the people we're lending money to are adhering to the principles of good financial behavior.

As reported by Reuters

We are slowing down. We are in for a prolonged period of slowdown because of the excess speculation that took place in housing. ... and the fact that liquidity ... is not getting out to the system as regularly as it should.

As reported by Reuters.

We are in a period of economic anemia and I think it's likely to be sustained for a little bit longer than people expect.

From press Q&A as reported by Bloomberg News

The U.S. economy will continue to suffer from a bout of anemia while the housing and financial markets settle down. I take comfort, however, in knowing that markets eventually clear if we at the Fed do our job and the other regulators and fiscal authorities do theirs. Even in the egocentric present, when gloomy analysts lament “unprecedented problems,” we must never lose faith in the economic machine that has propelled the U.S. economy to unprecedented prosperity.   

To a great extent, the bubble in housing was a classic case of the bigger-fool theory and efficient-market theory run amok.

Here is a simple analogy to help you think about our effort. The Federal Reserve is charged with conducting monetary policy that sustains noninflationary economic growth. We have at our disposal a tool called the federal funds rate, which we set as the base lending rate for the economy. Think of the fed funds rate as a monetary spigot, and the Fed’s goal is keeping the lawn of the economy green and healthy. If we turn the spigot up too forcefully, we will flood and kill the grass with inflation. If we provide too little, the lawn turns brown, starved for money. To get the money from the spigot to the lawn requires a working system of pipes and sprinkler heads. The “shadow banking system,” however, looks like a Rube Goldberg device designed by a hydrologist on acid, with pipes and conduits that lead every which way and not always toward the goal of sustainable economic growth. Moreover, the system of pipes and outlets is clogged with the muck and residue of a prolonged and frenetic period of unrestrained growth and abuse. Until the confusion and the debris are cleared away, financial intermediaries will be reluctant to book new loans or incur additional risk. This retards the impact of additional monetary accommodation.

Thus, even as we have been cutting the fed funds rate—even as we have been opening the monetary spigot—interest rates for private sector borrowers have not fallen correspondingly, and rates for some borrowers have increased. The grass is turning brown.

The Fed has made some tough judgment calls lately, and, having been party to making those calls, I can assure you they certainly were not made lightly. In principle, we know that the market should decide the winners and losers, who survives and who fails. I am a big fan of Winston Churchill. “It is always more easy to discover and proclaim general principles than to apply them,” Churchill said. I now know full well what he meant.

It's not that I've been against cutting rates. It's that the efficiency of the system that delivers those rate cuts to those who should benefit from them is out of whack.

From Q&A as reported by Market News International

I do not think we have exhausted our tool kit. But at the same time, the measures and initiatives that we have taken are to be considered against doing the minimum necessary to restore market efficacy.

From Q&A as reported by Reuters

The housing crisis may not yet have run its course, and further danger could lie ahead both for the nation and also for Texas. We may seem isolated from the rest of the nation’s woes, but we are not immune from the dangers they pose. Still, as I survey the Texan economic landscape, I sense we have an opportunity here. Our economy is growing. We’re an affordable and wonderful place to live. And we hunger for workers—as recently as this morning I heard anecdotal reports of labor shortages in parts of Texas.

Of course, like exotic foods, consumption of new risk products can lead to indigestion, and even allergic reactions. Lately, we have witnessed many allergic reactions—in the form of losses and setbacks—especially among money center banks and other financial institutions whose fiduciary eyes—as old Ruth Walgren would have said—“simply got too big for their stomachs.”

Globalization, once helpful in tamping down U.S. inflation by creating access to cheap labor, has become a headwind as demand for goods in developing nations rises rapidly, he said.

"Demand is in full force," Fisher said. "I do not see demand pressures being mitigated any time soon."

From Q&A as reported by Reuters

Markets are manic depressive ... interest rate differentials drive currency levels.

From Q&A as reported by Reuters, when asked about the dollar.

[The problems with LIBOR] do not hurt the efficacy of the liquidity programs put in place.

From Q&A as reported by Reuters

To wrap ourselves in the toxic, defensive mantle of protectionism ... is akin to embracing inflation as a remedy to the credit market correction [and therefore] a horrific mistake.

From Q&A as reported by Reuters

I especially appreciate Charlie’s mentioning my modest book collection. Part of that collection consists of documents and writings of British prime ministers. One of my favorites is Gladstone. He used to say that “only love has made more fools of men than contemplating the nature of money.” Yet, that is precisely what Charlie Evans and I and Ben Bernanke and our colleagues at the Federal Reserve do: We spend practically every waking hour contemplating the nature of money and the proper shape and conduct of our monetary system. So if you detect an air of distraction in Charlie Evans now and then, be kind. He has not gone mad or foolish on us; he is just hard at work noodling through our predicament and conjuring up Chicago’s recommendations on what we at the Federal Open Market Committee should do.

Last week in San Antonio, I provided my perspective on the situation we now encounter in a marketplace entering the early stages of recovery from a period of excess, indiscriminate behavior and historical (and occasionally hysterical) amnesia, and on the efforts we at the Federal Reserve are making to calmly and prudently restore the efficacy of the financial markets. I said then—and I assert again today—that there is nothing “unprecedented” about the situation we find ourselves in.

The United States, like Chicago, can continue to prosper only if it faces economic change head-on, choosing to compete rather than retreat, seeking out new opportunities in a globalizing economy, where goods, services, money and ideas flow freely across international borders.

One of these opportunities—maybe the best one—lies in exporting services.

[N]ow we must do what we can to remedy the situation. One thing, however, is clear. The answer, to be curt, is not to compound the bad by repeating the oft-prescribed remedy of inflating our way out of our predicament with a wing-and-a-prayer promise that it can always be reined in later. It is for this reason that I have maintained a strong reluctance to further general monetary accommodation. At the same time, I have been an advocate of using our various discount window facilities, within reason, to bridge the financial system’s structural problems as the credit markets correct themselves and run the long course of contrition.

While the word globalization has been defined in many ways, I believe it remains misunderstood by both the public and policymakers.

U.S. companies are ready to meet the world’s growing demand for services—but we will face competition. Staying ahead in
services trade requires well-educated workers and adroit managers; developing more of them will be key to selling our services to the world. Every chance I get, I stress the importance of education to good jobs and rising incomes in this country.

t’s really a question of, are we getting the bang for the buck? And clearly we’re not. The system was sputtering. And I began to feel that at 3.5%. After that, that’s when I dissented. Obviously for this next go-around, I have to watch to see if there is any change in signals. I’m just starting my briefings now for this.

What I’m hearing from CEOs is … the first quarter may have been positive, the second quarter’s probably not. There are real concerns about small businesses. Why? Because they’re not getting access to credit. … The credit system strikes me as being at the heart of the problem. And obviously the Fed has worked very hard on this. I’ve been in favor of every one of these [liquidity] initiatives. To me that’s where the priority is. To get the other to work the way we’re used to it working, it just strikes me that that has to get back to its efficient transmission mechanism.

I don’t know. You’re injecting your view into a roomful of views and depending on how you argue your viewpoint, and whether it has merit or not, and I think that’s very important. And so if it has merit, yes other people may listen. … The job of the 17 participants on the FOMC is to give an honest view. I honestly believe every one of my colleagues does that. Now, they might do it more forcefully in a certain area because they want to draw the attention of the committee to that area. A “negative feedback loop” – I won’t mention the name of the individual – on the economy or in my case inflationary pressures that are building. So you might emphasize saying more than the rest.

I think every single person on the committee basically is pursuing the truth. It’s the only place in government you can do it. People don’t dislike you for it. When [Richmond Fed President] Jeff Lacker was dissenting last year, we’d sit down at lunch afterward and pat him on the back – “Good try, pal” or “I hadn’t thought about that” or “That’s an interesting viewpoint.” … There’s no enmity. And it’s an honest intellectual debate. I don’t think anybody’s trying to sway anybody else. I think they’re trying to just get what they feel out on the table. And it’s up to the group to decide if it’s valid or not.

…I think the market should look at what the group decides. Even if you have dissents. It’s what was decided as a group and what signals are being sent.

When asked whether dissents have a cumulative effect

Will the U.S. slowing down really damp the price of oil, or the price of food, rice, or flour, cornmeal, the price of steel? … It’s not clear to me that a mild slowdown will put a dent in price pressures domestically. Obviously if you have a tail risk of a very severe global slowdown, then yes, I can see that. I don’t see that in the cards at least from my limited perspective. If you think in closed-economy terms, that’s more likely to obtain. If you think in global terms, it is less likely to obtain unless the whole world slows down.

The thing that I admire about Ben [Bernanke] is that right away – without a nanosecond’s time — he was thinking through these issues that I think should’ve been thought through before. But they weren’t; there were other priorities. The question is: what is the efficacy of further rate cuts?

You have to put into perspective the way I behaved on fed funds in the context of how the system works or does not work. When we got to 3.5% [at January’s unscheduled policy meeting] and were starting to go below that, my personal bias was to make sure we got all of the plumbing working. The question really is about the efficacy of the system. Will consumers and small businesses benefit from these rate cuts?

When asked about his "strong reluctance" to further easing.

Mr. Fisher was concerned that an adverse feedback loop was developing by which lowering the funds rate had been pushing down the exchange value of the dollar, contributing to higher commodity and import prices, cutting real spending by businesses and households, and therefore ultimately impairing economic activity.

My recommendation is that you take it [the April 30 FOMC statement] at face value. There are risks on both sides. There are tail risks, as the economists like to call them, on both sides.

We're in the business of risk management in that sense. We have a dual mandate. We have to (monitor) growth and inflation. The readers can study our entrails all they want. That's what makes it interesting. It says what it says, and that's all I'm going to say.

Personally, for me to change course, given that I stopped (supporting rate cuts) at 3 1/2 percent, I'd have to see a very dramatic economic slowdown going on beyond what I'm already discounting.

I'm already discounting significant anemia,

Personally, I want to see these inflation expectations mitigated, and I need to think through, in terms of my input into the process, whether and when it makes sense to argue for increases as opposed to just stopping the cutting.

That's a personal thing, and I'm just one of 17 people, and that depends on how -- to me -- whether or not we see some mitigation of inflation pressures and expectations without seeing an intensification of the economic anemia I spoke of earlier,

Personally, I"m concerned about inflation and the negative feedback loop, which is that inflation leads to changes in consumption and business patterns that further retard economic growth as well as to pressures in the foreign exchange markets.

So I think there is a risk of a negative feedback loop that derives from cutting rates. So that's one of the reasons I've been resistant.

That's not noise.That's a signal.

On oil prices reaching $120 a barrel and other energy demand trends.

Gold is down, and I consider that to be a sign -- just one of a jillion, and I wouldn't overweight it -- that the marketplace considers the Fed serious about inflation -- not just me or somebody else -- but the Committee.

It may be that the recent statements made by the Open Market Committee and the recent actions are engendering greater confidence in the dollar. We'll see over time.

... [Currency markets are] manic depressive ... they overshoot. We've had some volatility there, and I'd like to remind people that a lot of people made a mistake by selling the U.S. economy short for a long time.

[Fisher said he is] entertained when I read that today the dollar was weak or yesterday the dollar was weak because the U.S. economy is showing slower growth, then the next day it says it's because inflation was reported higher. I always feel like screaming, "Guys, make up your mind!" So I"m not surprised that the dollar strengthened. The question is what is the trend over time. ... You have to keep in mind that these are manic depressive mechanisms that overshoot on both sides. They're very emotional.

There still is growth in the world economy, even if we slow down. It's difficult for me to see a supply response that will feed into that demand to relieve all the price pressures we see on oil.

As reported by Reuters

How deep that slowdown will be is a question mark, ... I am not sure it will be very deep at all, but it may be prolonged, because we have to correct the excesses of this credit crisis.

As reported by Bloomberg News

"I can't tell you how many times people now ask me: Just how did you get to Annapolis and to Harvard and all those fancy schools? How did you end up on Wall Street, make money, become an ambassador and do all those high-sounding things in Washington? How did you end up working with Henry Kissinger? And how did you end up sitting at the table with Alan Greenspan and Ben Bernanke at the Federal Reserve? What's your secret?

``An honest answer requires the ultimate disclaimer that it helps to have good luck on your side -- serendipity comes in mighty handy. I have had way more than my share of it. But I believe that the lessons and disciplines learned at Farragut, just like those you have learned, are what allowed me to make the most of that good luck.''

As reported by Bloomberg News

 

I am tempted to think of him as somewhat Buddha-like. He’s developed a serenity based on a growing understanding of the hardball ways the system actually works. You can see that it’s no longer an academic or theoretical exercise for him.

We saw a debauching of the credit system. To correct that, financiers, whether they be banks or homeowners, will be more cautious as they proceed.

As reported by Market News International

You might wonder why a central banker would be concerned with fiscal matters. Fiscal policy is, after all, the responsibility of the Congress, not the Federal Reserve. Congress, and Congress alone, has the power to tax and spend. From this monetary policymaker’s point of view, though, deficits matter for what we do at the Fed. There are many reasons why. Economists have found that structural deficits raise long-run interest rates, complicating the Fed’s dual mandate to develop a monetary policy that promotes sustainable, noninflationary growth. The even more disturbing dark and dirty secret about deficits—especially when they careen out of control—is that they create political pressure on central bankers to adopt looser monetary policy down the road.
...
Earlier I mentioned the Fed’s dual mandate to manage growth and inflation. In the long run, growth cannot be sustained if markets are undermined by inflation. Stable prices go hand in hand with achieving sustainable economic growth. I have said many, many times that inflation is a sinister beast that, if uncaged, devours savings, erodes consumers’ purchasing power, decimates returns on capital, undermines the reliability of financial accounting, distracts the attention of corporate management, undercuts employment growth and real wages, and debases the currency.

Purging rampant inflation and a debased currency requires administering a harsh medicine. We have been there, and we know the cure that was wrought by the FOMC under Paul VolckerEven the perception that the Fed is pursuing a cheap-money strategy to accommodate fiscal burdens, should it take root, is a paramount risk to the long-term welfare of the U.S. economy. The Federal Reserve will never let this happen. It is not an option. Ever. Period.

Our deliberations are quite civil. I defy you to find any place in government that operates that efficiently ... I think perhaps it is the last deliberative body that is totally civil.  
...
I don't ever feel restrained speaking as a Federal Reserve official. I don't have to clear my speeches ... I think that's unique.

From Q&A as reported by Market News International

I think he has been battled hardened. I think we all have been battle hardened. We found that the pipes in the great sprinkler system we call the economy were clogged  ... We needed to change our tool kit ... I think his pragmatic hardball approach has been very
productive.

From Q&A as reported by Market News International

Ben has a charming sense of humor ... He is not only prodigiously smart, but I think that the best thing that happed to him is that he served on a school board in New Jersey ... It allows him to run a meeting with harmony and results.

From Q&A as reported by Market News International

Right now, we—you and I—are launching fiscal bombs against ourselves. You have it in your power as the electors of our fiscal authorities to prevent this destruction. Please do so.

Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets.

From Q&A as reported by Bloomberg News

Alan Greenspan and Paul Volcker, two of Ben Bernanke’s linear ancestors as chairmen of the Federal Reserve, have been in the news quite a bit lately. Yet, we rarely hear about William McChesney Martin, a magnificent public servant who was Fed chairman during five presidencies and to this day holds the record for the longest tenure: 19 years.

Chairman Martin had a way with words. And he had a twinkle in his eye. It was Bill Martin who wisely and succinctly defined the Federal Reserve as having the unenviable task “to take away the punchbowl just as the party gets going.” He did himself one up when he received the Alfalfa Club’s nomination for the presidency of the United States. I suspect many here tonight have been to the annual Alfalfa dinner. It is one of the great institutions in Washington, D.C. Once a year, it holds a dinner devoted solely to poking fun at the political pretensions of the day. Tongue firmly in cheek, the club nominates a candidate to run for the presidency on the Alfalfa Party ticket. Of course, none of them ever win. Nominees are thenceforth known for evermore as members of the Stassen Society, named for Harold Stassen, who ran for president nine times and lost every time, then ran a tenth time on the Alfalfa ticket and lost again. The motto of the group is Veni, Vidi, Defici—“I came, I saw, I lost.”

Bill Martin was nominated to run and lose on the Alfalfa Party ticket in 1966, while serving as Fed chairman during Lyndon Johnson’s term. In his acceptance speech,[1] he announced that, given his proclivities as a central banker, he would take his cues from the German philosopher Goethe, “who said that people could endure anything except continual prosperity.” Therefore, Martin declared, he would adopt a platform proclaiming that as a president he planned to “make life endurable again by stamping out prosperity.”

“I shall conduct the administration of the country,” he said, “exactly as I have so successfully conducted the affairs of the Federal Reserve. To that end, I shall assemble the best brains that can be found…ask their advice on all matters…and completely confound them by following all their conflicting counsel.”

If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic' [economy].

From Q&A as reported by Bloomberg News

I think we’ll have a long period of anemic economic activity, it’ll take a while as bank and lending officers tighten their criteria. But it doesn’t mean we’ll have a recession.

From Q&A as reported by the Wall Street Journal economics blog.

This is bigger than the S&L. It's broader. It's deeper.  It's not unhealthy. It's the way capitalism works.

I expect that in the second half of this year we will broach zero growth.

As reported by Reuters.

We'll probably have to move ahead of what everybody else perceives to be the turn, assuming that we still see some pressure on the cost front. The question is when is that turn, and I don't have an answer to that.

As reported by Bloomberg.

Unless the python that is the U.S. economy can quickly pass the recent burst of cost-push pressures, we risk a reinforcing spreading of inflationary impulses and expectations. Should this happen and the Fed were to fail to address it, we would run the risk of losing the public’s confidence in our ability to constrain inflation. Then the great editorial writers in this country, to say nothing of Congress and the American people, will be calling for all of us—doves and hawks alike—to be shot (metaphorically speaking, of course).

Labor costs at home have been restrained. But labor costs in other places where American companies produce and source goods, particularly China, have been rising dramatically.
...

The Chinese Ministry of Human Resources and Social Security reports that in the first half of this year, wages in urban areas, where most U.S. and foreign firms make or assemble products, rose 18 percent. And, as any U.S. firm operating in China will tell you, recent stepped-up enforcement of job rules has made China an even more expensive place to operate.

I cannot tell you how much we should weigh this particular cost component. Nobody knows the answer to how this impacts cost structures here at home. But this much is clear: The tailwind that was holding labor costs at home hostage to the threat of outsourcing production to China has been significantly mitigated. Any garment producer or hospital equipment maker or high tech assembler operating in China can testify to that.

In addition, as income levels have risen in the emerging countries, so has their appetite for raw materials and basic necessities.

The markets in commodities, like those of stocks and bonds, are manic-depressive mechanisms and overshoot on the upside as well as on the downside. One could reasonably deduce from recent price reversals in oil and food prices that they overshot on the upside and that their price run-up was a one-off development. If you subscribe to this argument, you envision a process not unlike that of a python digesting dinner: It visibly moves through the system, creating some moments of discomfort—in this case, a temporary inflationary bulge—but is processed in reasonable time and done with.

I expect U.S. economic growth will decelerate to a snail’s pace, if not completely grind to a halt, in the second half of this year. Indeed, we may see the slowdown extend into 2009 as the excesses that drove the housing markets unwind before the economy can again gear up to cruising speed. Then, as 2009 unfolds, it is quite possible that the economy will resume a more normal growth trajectory.

"Growth will taper down...to a snail's pace in the second half," and it "may be anemic for a while," Mr. Fisher said, adding that he "could see us approaching" zero growth during the latter half of the year due to the "enormous stress" created by financial markets, which remain strained.
…
"The real concern I have as a central banker is whether or not [inflation] begins to affect the...spending patterns by consumers [and] pricing patterns by producers," Mr. Fisher said.

"I don't know the answer to that question," he said, adding that the odds are even whether inflation gains prove a "one-off event" or more persistent. He fears the latter scenario may be more likely.

"I have been most concerned" that expectations of further price increases will become embedded in the economy.

And while the recent pullback in energy and commodity prices is encouraging, Mr. Fisher said "it's too early to take comfort in these reversals."
...
Mr. Fisher said he is confident the committee "won't do what is required" to bring price pressures back in line.

In Admiral Smith’s parlance, having sailed the economy along for years in a tranquil following sea, we are now navigating Force 10 conditions. To be sure, on the growth front we have managed to make better headway than most everyone expected under the circumstances: To everyone’s surprise, our $14 trillion economy grew at a 3.3 percent annualized rate last quarter, meaning that the American economy produced almost $29 billion more in the second quarter than it did in the first.

That said, looking off the bow, I see nothing on the horizon that would lead me to conclude anything different than what I articulated in Aspen: The data received since then on personal consumption expenditures, real capital expenditures and construction show the third quarter off to a weak start, although yesterday’s manufacturing numbers were a nice surprise on the upside. I think it is very likely we will suffer anemic growth for the current and perhaps the next couple of quarters. But I want to lay down a caveat: What bothers me is that this is a widely held view. I learned over the years as a market operator that the consensus view is almost always wrong. American entrepreneurs and business leaders are ingenious in figuring out how to overcome obstacles that might befall lesser capitalists. Still, I think it likely that our movement through the muck and the flotsam and jetsam of the credit and housing debacle will be sluggish, and it may take some time into 2009 for us to get the economy back up to a snappier cruising speed.

As to the inflation outlook, there appear to me to be even odds that one of two scenarios will obtain.

The first calls for slowing domestic and economic growth to dampen the inflationary surges we have seen of late.
...
The other probable scenario assumes that rather than passing through as a “one-off" event, there is some spreading of the inflationary pressures we have been experiencing...After companies have had their margins gutted by dramatic rises in their cost of goods sold, one can envision them being a little skeptical about the durability of recent price retrenchments in the commodities markets and taking advantage of every opportunity to buy protection from being victimized again. Under this scenario, consumer prices prove sticky on the downside.

The jury is still very much out as to which scenario will obtain.

I think it is very likely we will suffer anemic growth for the current and perhaps the next couple of quarters. .... Still, I think it likely that our movement through the muck and the flotsam and jetsam of the credit and housing debacle will be sluggish, and it may take some time into 2009 for us to get the economy back up to a snappier cruising speed.  

Since the beginning of the year, I have been worried about the efficacy of reducing the fed funds rate given the problems of liquidity and capital constraints afflicting the financial system. As I see it, the seizures and convulsions we have experienced in the debt and equity markets have been the consequences of a sustained orgy of excess and reckless behavior, not a too-tight monetary policy.

There is no nice way to say this, so I will be blunt: Our credit markets had contracted a hideous STD—a securitization transmitted disease—for which lowering the funds rate to negative real levels seemed to me to be not only an ineffective treatment, but a palliative and maybe even a stimulus that would only encourage further mischief.

One of the greatest of Federal Reserve chairmen, William McChesney Martin, once said that the job of the Fed is “to take away the punch bowl just as the party gets going.” As I speak to you today, we are in the midst of experiencing the consequences of the failure to take away the punch bowl and of allowing the exuberant “animal spirits” of our economy to get out of hand. We must never allow this to happen again.

You can see the size and breadth of the Fed’s efforts to counter the collapse of the credit mechanism in our balance sheet. At the beginning of this year, the assets on the books of the Fed totaled $960 billion. Today, our assets exceed $1.9 trillion. I would not be surprised to see them aggregate to $3 trillion—roughly 20 percent of GDP—by the time we ring in the New Year. The composition of our holdings has shifted considerably. Previously, almost 100 percent of our holdings were in the form of core holdings of U.S. Treasuries; today, less than a third are. The remainder consists of claims deriving from our new facilities.

You will note that the emphasis of our activities has been on expanding the asset side of our balance sheet—the left side, which registers the securities we hold, the loans we make, the value of our swap lines and the credit facilities we have created. We feel this is the correct side to emphasize. The right side of our balance sheet records our holdings of banks’ balances, Federal Reserve Bank notes or cash (currently over $830 billion) and U.S. Treasury balances.

When the Japanese economy went into the doldrums, the Bank of Japan emphasized the right side of its balance sheet by building up excess reserves and cash, only to find that accumulation did too little to rejuvenate the system.

As I said earlier, in times of crisis many feel that the best position to take is somewhere between cash and fetal. But it does the economy no good when creditors curl up in a ball and clutch their money. This only reinforces the widening of spreads between risk-free holdings and all-important private sector yields, further braking commercial activity whose lifeblood is access to affordable credit. We believe that emphasizing the asset side of the balance sheet will do more to improve the functioning of credit markets and restore the flow of finance to the private sector. In the parlance of central banking finance, I consider this a more qualitative approach to “quantitative easing.” It is bred of having learned from the experience of our Japanese counterparts.

The most cogent description of this year’s economic developments might best be summarized by a woman who, having just commiserated with her accountants, put it this way: “This has been like the divorce from hell: My net worth has been cut in half and I’m still stuck with my husband.” The mood and pace of the economy have shifted from near bliss to acrimony and an almost palpable sense of betrayal. Many of our fellow citizens feel trapped in an unsustainable situation.

I think we're going to have a rough couple of quarters here and then a slow recovery.

The only description of recent economic developments I have heard that is as cogent came from a woman who, having just commiserated with her accountants, put it this way: "This has been like the divorce from hell: My net worth has been cut in half and I'm still stuck with my husband." The mood and pace of the economy have shifted from near bliss to acrimony and an almost palpable sense of betrayal. Our self-confidence has gone wobbly. Many of our fellow citizens feel trapped in an unsustainable situation. The challenge facing the new president is daunting.

The Federal Reserve must, of course, be very careful to avoid any perception that it stands ready to monetize exploding fiscal deficits, as this would undermine confidence in our independence and raise serious doubts about our commitment to long-term price stability. These concerns certainly do not preclude some Treasuries purchases, however, as we seek to strengthen the economy in this time of crisis. With short-term Treasury rates near zero, an argument can be made that buying longer-term Treasuries would be especially effective in this regard.

Parenthetically, I would note that such purchases are not at all unusual. We routinely buy Treasury issues with a wide range of maturities in order to maintain a well-balanced portfolio. So, we are talking only about a possible change in emphasis here, not a sharp departure from past practice. That said, in my opinion, we certainly shouldn't try to peg long-term rates. Past efforts to do so soon have led to costly credit-market distortions and inevitably ended in tears. In my view, we must be very careful not to provide for an unsustainable and potentially disruptive distortion in the benchmark market for Treasuries through any extraordinary efforts above and beyond our normal balancing operations.

Similarly, we must be very cautious about the dimensions of our program to intervene directly in the market for asset-backed securities, making sure that our actions are the absolute minimum needed, and no more. Most important of all, we must continue to make clear that we will unwind our interventions in the market and shrink our balance sheet back to normal proportions once our task is accomplished, for this is, indeed, our unanimous and unflinching intention.

When George Shultz was director of the Office of Management and Budget, he became frustrated with the spending impulses of the Nixon administration. He reports that he called the venerable Sam Cohen, a virtual encyclopedia of budgetary history, into his office and asked, "Between you and me, Sam, is there really any difference between Republicans and Democrats when it comes to spending money?" Cohen's reply was classic: "Sir, there is only one difference: Democrats enjoy it more."

P. G. Wodehouse, my favorite comedic author, used to say that "there is only one cure for gray hair. It was invented by a Frenchman. It is called the guillotine." But my colleagues at the Federal Reserve and I refuse to be fatalistic. (Besides, those of us who still have hair have seen it turn gray this past year.) Though in normal times, central bankers appear to be the most laconic genus of the human species, in times of distress, we believe in the monetary equivalent of the Powell Doctrine: We believe that good ideas, properly vetted and appropriately directed with an exit strategy in mind, can and should be brought to bear with overwhelming force to defeat threats to economic stability.

This is humbling in more ways than one. Yesterday morning, as I got on the plane to fly up here, I turned to Nancy and said, "In your wildest dreams did you ever envision me following in the footsteps of George H. W. Bush, David Rockefeller and Ban Ki-moon in giving the Gordon Lecture at the Kennedy School?" And she replied, "I hate to let you down, Richard, but after 35 years of marriage, you rarely appear in my wildest dreams."

Our task is to turn the current "annus horribilis" into an opportunity, just as the Brits did 350 years ago—to emerge from the current economic wreckage stronger and better and more resilient than ever. If England could do it in the 17th century, we Americans, who face a far lesser challenge and have never, ever flinched from staring down and overcoming adversity, can certainly do it now. Turning something "horribilis" into a thing that is "mirabilis" is the American thing to do.

Viewed from this perspective, the current economic and financial predicament represents a potential gold mine rather than a mine field. Historically, great investors have made their money by climbing a wall of worry rather than letting a woeful consensus cow them.

I consider inflation an evil spirit that rots the core of economic prosperity and must never, ever be countenanced. But it is clear to me that in this environment, inflation is unlikely to present a serious threat given the pervasive bias in the U.S. economy toward wage cuts and freezes, rising unemployment, the widespread loss in wealth that has resulted from both the housing and equity market corrections, continually declining consumption and business investment, and the anemic condition of the banking and credit system, all of which reinforce downside price pressures in a global economy groaning with excess capacity.

I expect the unemployment rate to continue rising to a level that could surpass 10 percent by year-end.

I have a reputation for being the most “hawkish” participant in the deliberations of the Federal Open Market Committee. I do not particularly like ornithological nomenclature—I would rather be considered a wise owl (and I certainly do not wish to be anybody’s pigeon). But I have a record that substantiates that “hawkish” reputation, having voted five times against monetary accommodation during the commodity-driven price boom of 2008. I consider inflation an evil spirit that rots the core of economic prosperity and must never, ever be countenanced. But it is clear to me that in this environment, inflation is unlikely to present a serious threat given the pervasive bias in the U.S. economy toward wage cuts and freezes, rising unemployment, the widespread loss in wealth that has resulted from both the housing and equity market corrections, continually declining consumption and business investment, and the anemic condition of the banking and credit system, all of which reinforce downside price pressures in a global economy groaning with excess capacity.

[A]s far ahead as I trust my forecasting ability[5] (that is to say, the next couple of years), the problem with regard to maintaining price stability most certainly is not inflation.

[D]emand for Treasuries and other official paper of U.S. government issuers will be determined by their attractiveness relative to alternatives, and they may well be judged more, rather than less, attractive under most reasonable future scenarios.

In my time at the Federal Reserve, starting in 2005 and working predominantly under the chairmanship of Ben Bernanke, my colleagues and I have been focused primarily on finding a way to undo past errors and mend the system. I believe that the initiatives taken by my fellow “banksters” at the Federal Reserve prevented us from falling into the chasm of an economic depression.

We have been very careful to calibrate our actions so as to accommodate the needs of credit markets and the economy, not political imperatives. We are well aware that some of our balance sheet additions, designed to pull markets and the economy from the edge, have raised a few eyebrows (like the $1.25 trillion in mortgage-backed securities we have pledged to purchase if necessary—although it has unquestionably driven mortgage rates to historic lows). And while it is not unusual for the System Open Market Account to buy Treasuries along the yield curve, the FOMC’s decision to purchase $300 billion in U.S. Treasuries—a decision made to improve the tone in the private credit markets—has been viewed by some as skating a little too close to the edge of political accommodation.

I can tell you that the FOMC is well aware of the doubts being voiced about its intentions. I can also tell you that nobody I know on the committee wants to maintain our current posture for any longer and to any greater degree than is minimally necessary to restore the efficacy of the credit markets and buttress economic recovery without inflationary consequences. Indeed, as I speak, we are studying ways to unwind our balance sheet in a timely way.
...
[T]here are concerns that the Federal Reserve will be politicized. For example, some have called for increased congressional involvement in the selection of Federal Reserve policymakers and a reduced role for member banks. I trust that the Congress will resist this initiative and not upset the careful federation that has for so long balanced the interests of Main Street with those of Washington, just as we at the Federal Reserve must resist the urgings of some to accommodate the short-term financing needs of the Treasury.

Under these conditions, I envision a slow recovery. Not a V-shaped snapback—nor even a U-shaped one—but a very slow slog as we find a more sensible and sustainable mix between consumption and savings and investment.

You know the numbers that have been reported for the nation for the first quarter: Even after upcoming revisions, I venture we’ll find we contracted at somewhere between 5 and 6 percent at an annual rate. The pace of decline will moderate in the current quarter, and then we’re likely to bounce along the bottom for a while, perhaps punching through to positive growth as 2010 dawns. I would be delighted, but surprised, if meaningful sustained growth gets under way any earlier. Regardless, increases in unemployment, while mitigated by the expansion of government (particularly the need for census takers) will likely take us to a 10 percent jobless rate before we reverse course. And global excess capacity is likely to remain excessive for some time to come.

As to price stability—the touchstone of central banking—given the vast amount of slack worldwide, the near-term outlook for inflation is meek. Indeed, the recent pressures have been to the deflationary side, though we seem to have beaten that back.

Neither deflation nor inflation engenders confidence. Both distort decisionmaking of households as well as businesses. Both inhibit sustainable employment growth. If you want to know the outlook for inflation over the next quarter or next year, look at current domestic and global slack: It is doubtful that inflation will raise its ugly head until employment and capacity utilization tighten. Looking further out, however, Milton Friedman—whom many consider the Moses of monetary policy—reminds us that inflation, defined as “a steady and sustained rise in prices,” is “always and everywhere a monetary phenomenon.”[4] Bearing this in mind, we must be careful with the deployment of our monetary initiatives.

[L]ooming before us is the prospect of a heavy calendar of debt issuance by the Treasury. Between now and the end of the current fiscal year in October, the Treasury will issue just over $1 trillion in net new debt, with at least that much to follow in fiscal 2010. As the Book of Volcker warns, the Federal Open Market Committee can ill afford to be perceived as monetizing that debt, lest we come to be viewed as an agent of, rather than an independent guardian against, future inflation.

I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.
...
Throughout history...what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can't let that happen. That's when you open the floodgates. So I hope and I pray that our political leaders will just have to take this bull by the horns at some point. You can't run away from it.

As reported by Wall Street Journal.

I am pleased to see that the new administration has embraced what was hitherto perceived as the third rail of American politics and brought the issue of unfunded entitlement liabilities to the fore. For the sake of our grandchildren, I hope that the administration and the Congress will take this vexing beast of a problem by the horns and tame it.

[F]rom what I can detect from the activity of so-called indirect bidders in Treasury auctions—indirect bidders submit competitive bids through others rather than directly; central banks are among those who commonly bid indirectly—there continues to be strong demand for longer duration Treasuries—again, contrary to rumors and press reports. Thus, to date, our actions have not given rise to concern that we will violate Paul's Dictum.

[W]hile the announcement that the Social Security trust fund will begin its decline one year earlier is an important fiscal event, the swelling of overall entitlement debt to more than one hundred trillion dollars has far more serious implications for economic growth—implications we are poorly positioned to address given the budget deficits we face today.

Our successor generations are coming to grips with this daunting reality. Faced with the prospect of a government that they believe may be unable to deliver on its promise of long-term fiscal balance—particularly with regard to entitlement programs—these individuals might logically begin to alter their consumption patterns, spending less today to save more for tomorrow. There is nothing wrong with increasing savings. But, in an economy driven by consumption, this intertemporal hedging may dampen the pace of future economic growth.

I would love to be a screeching hawk once again, but I just don't think it is appropriate presently.

[T]here's too much slack in the system right now. And I don't see inflationary pressures rearing their ugly heads particularly if we conduct ourselves properly, which I believe we are doing.

I don't see the Chinese doing anything that would damage the United States. It's in their interest - and in a way they're in bed with us as investors and savers.

Personally, the idea of our tightening from where we are, I don't see it in the immediate future.

[W]hile one can argue that by agreeing to purchase up to $300 billion in long-term U.S. Treasuries, the FOMC provided a needed short-term tonic to private credit markets, we dare not come to be viewed as a handmaiden to the Treasury. By loosening the anchor we have established for long-term inflation expectations, we could create the perception that monetary policy is subject to political imperatives, doing lasting damage to our ability to maintain price stability and restore full employment. I believe we have come as close as we dare to the line between acceptable and unacceptable risk in this regard, and do not personally wish for us to expand or extend our purchases of Treasuries beyond the cumulative $300 billion planned by this fall.

Given the expected slow adjustment rate of the other components of final demand, my guess is it will be a long time before we see growth strong enough and sustained enough to make an appreciable dent in excess capacity. I envision an output path going forward from here that looks something like a check mark, with the Johnny Mercer effect giving us a near-term snapback from the short, intense downstroke, followed by a transition to a long period of slower growth corresponding to the elongated side of the mark.

[F]or the immediate future, the risk to price stability is a deflationary risk, not an inflationary one.
...
[W]e are likely to see a prolonged period of sluggish economic performance and uncomfortably high unemployment as businesses reallocate capital and labor to fit the new economic landscape.

Given the lag between the time monetary policy is initiated and when it impacts the economy, that wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction and that the lending capacity of the banking system is capable of expansion. Cynics retort that "the Fed may know what to do—but will it have the guts to pull the trigger?" Well, we Texans are not afraid to pull the trigger (as anybody knows who has gone duck hunting with vice presidents of the United States!). I have faith my colleagues on the Federal Open Market Committee will stand and deliver in a timely way.

[T]here are presently some signs that the economy is stabilizing and even reviving in certain areas, despite mixed signals.
...
Given both the monetary accommodation we at the Fed have put in place and the stimulus of fiscal policy, it is now reasonable to expect a gradual resumption of economic growth in a context of price stability.

Fans of campy science fiction films know all too well that outsized monsters can wreak havoc on an otherwise peaceful and orderly society.

But what B-movie writer could have conjured up this scary scenario—Too Big To Fail (TBTF) banks as the Blob that ate monetary policy and crippled the global economy? That's just about what we've seen in the financial crisis that began in 2007.

Many of the Fed’s special credit facilities have been winding down at a rapid clip as financial markets have begun to function in a more normal manner. And my colleagues have come to accept the arguments I made regarding the necessity for the Fed to maintain its independence from the Treasury by not increasing its purchases of long-term Treasury securities. As to the Federal Reserve reducing its balance sheet so as not to monetize the excess reserves waiting to be converted to bank loans, I have been very clear: Given the lag between the time monetary policy is initiated and when it impacts the economy, that wind-down process needs to begin as soon as there are convincing signs that economic growth is gaining traction and that the lending capacity of the banking system is capable of expansion.

I am not alone on this front. I have faith my colleagues on the Federal Open Market Committee will stand and deliver in a timely way. And I expect that when it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that with which we pursued monetary accommodation.

Though policy makers are vigilant for signs of when to remove the central bank's assistance, "the question is what is the appropriate time," Fisher said.  "It is not right now."

The central banker, who isn't a voting member this year on the Federal Open Market Committee that decides policy moves, offered no insight into when the Fed might lift its target interest rate from the historic low it's held since December last year. Asked about speculation that the first post-crisis rate hike could come mid-2010, Fisher said, "that depends on the circumstances."   The Fed would act to head off potential inflationary pressure from its current "accommodative" stance, he said, but this isn't a risk for the time being, while conditions remain so fragile. "The issue right now is excess slack," he said, noting "disinflationary forces acting on the economy."

As reported by Dow Jones Newswires from an NBR interview

 

Federal Reserve Bank of Dallas President Richard Fisher said interest rates in the country won’t “imminently” be increased.

   

Consider this passage from Book III of Milton’s Paradise Lost, where God answers the question of why He created men and angels who could rebel against Him. Of man, He responds:

“… I made him just and right,
Sufficient to have stood, though free to fall.
Such I created all th’ ethereal Powers
And Spirits, both them who stood and them who failed;
Freely they stood who stood, and fell who fell. …”[1]

As is clear from this most celebrated work of literature, the issue of whether entities—be they mortal or divine—should be allowed to fail is one of the oldest philosophical quandaries.

I think back to my mother’s admonition: “You can’t expect to get by in America just relying on your looks or your athletic ability.”

Now, let me be clear: I do not believe the Fed to be blameless in the run-up to the crisis we are now working our way out of. For quite some time, I have respectfully differed with Chairman Bernanke, saying that I felt the Fed held interest rates too low for too long in the early half of the 2000s, thus fueling reckless speculation in housing and other sectors. And I have freely admitted that a host of regulators, including those at the Federal Reserve, were caught unawares by the risk being taken by large financial institutions that later came a cropper.

The dangers posed by TBTF banks are too great. To be sure, having a clearly articulated “resolution regime” would represent steps forward, though I fear they might provide false comfort in that a special resolution treatment for large firms might be viewed favorably by creditors, continuing the government-sponsored advantage bestowed upon them. Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size—more manageable for both the executives of these institutions and their regulatory supervisors. I align myself closer to Paul Volcker in this argument and would say that if we have to do this unilaterally, we should. I know that will hardly endear me to an audience in New York, but that’s how I see it. Winston Churchill said that “in finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis.

We deceived ourselves to think that we could somehow avoid the way people are.

As you know, monetary policy is highly accommodative. And I think this stance is appropriate at present. I continue to support the substance of the policy the FOMC articulated in recent meetings. That is, economic conditions warrant a low federal funds rate target for an extended period. Markets are highly interested in the meaning of "extended period." I don't think it is appropriate to talk in terms of a specific timeframe or number of meetings.

You might well ask the "what if" question regarding Treasury borrowings. "What if the insatiable borrowing of the Treasury leads to upward pressure on rates? Would the Fed then step in and buy a bundle of Treasuries just to hold rates down?" I think not. For, should we do so, we would only become an accomplice to the fiscal incontinence of Congress. We would be perceived as "monetizing the debt," a trap that inevitably leads to hyperinflation and economic destruction. We would lose all the hard-earned credibility we have gained by our conduct in the crisis if we came to be viewed by markets as a handmaiden of spendthrift political forces. That would be a bit of lead piping we could ill afford.

Earlier this week, I prepared for this lecture by speaking to some of your undergraduate students by phone. One of the most memorable of them described the Fed's balance sheet as being "really pimped out!" I would not have chosen those words, but, yes, our balance sheet is presently gussied up. We aim to get back to the basics of holding mostly plain vanilla Treasuries—in size needed solely for conducting prudent monetary policy—on the asset side of our balance sheet. And we wish to have banks put their reserves to work, financing growth of the businesses of America, rather than piling those reserves up on the liability side of our balance sheet.

Because of the enormous slack in the system, and as you know I tend to be very vigilant about inflation, we’re just not seeing price pressures right now. If anything, the tail risks are on the deflationary side.

Winston Churchill said that “in finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because we now know it surely cannot be done in the middle of a crisis.

We have politely made clear in all our speeches ... that we will not monetize the deficits.

Some Fed officials regret the U.S. central bank's decision to purchase $300 billion in longer-term Treasury securities during the crisis because it suggested the Fed was prepared to fund the U.S. fiscal shortfall, Fisher said.

[The "extended period" language is] there, we'll deal with it as appropriate at the right time... It's a question of when the conditions are proper for beginning to signal that we are going to be tightening monetary policy, and I don't think we are there yet.

As far as the general question of tightening monetary policy, that depends on the course of the economy.

"We need clarity" in light of things such as the passage of major health-care and financial regulatory-reform legislation, and that is now lacking, Federal Reserve Bank of Dallas President Richard Fisher told CNBC television Wednesday.

"There is too much confusion" right now and that is leading to slower economic growth, Fisher said.

"No amount of further monetary accommodation is going to do the trick,” he said in response to audience questions after a speech today in San Antonio. “We’ll be pushing on a string, in my opinion.”

I have reported to my colleagues at the FOMC that the prevailing sentiment among these business operators is that the politicians and officials who craft and enforce the rules are doing so in a capricious manner that makes long-term planning difficult, if not impossible. They are increasingly distressed by the lack of consistent direction coming from Washington. They are confused and dispirited by random refereeing. So they are calling time-outs and heading to the sidelines while they wait for the referees to settle on the rules of the game.

If this is so, no amount of further monetary policy accommodation can offset the retarding effect of heightened uncertainty over the fiscal and regulatory direction of the country. As long as our economic players—businesses and consumers—are beset by unmanageable uncertainty, they will refrain from making decisions that provide the stuff of economic growth. Indeed, one could posit that further monetary accommodation might make the situation worse if private sector operators were to conclude that the Federal Reserve has become politically pliable and is prone to substituting such accommodation for fiscal discipline.

I think it is abundantly clear to the market that regardless of the language the FOMC employs to describe its deliberations and intentions, the consensus of the committee is to keep the price of money—the cost of the gas needed for our nation’s economic engine—low until the committee is confident that the gears of the economy have begun to mesh more robustly.

Which focuses attention on the size of our balance sheet and whether we will expand it. Personally, I would be reluctant to do so unless or until fiscal and regulatory initiatives are aligned with the needs of job creators. Otherwise, further accommodation might be pushing on a string.   In the worst case, it could flood the engine of the economy with gas that might later ignite inflation. Of course, if the fiscal and regulatory authorities are able to dispel the angst that they are reportedly causing, further accommodation may not be needed because the liquidity that has been built up on corporate balance sheets and in the excess reserves of banks might then be released into the economy and spur job creation.

What I envision from the current vantage point is an anemic recovery, but not one that slips into reverse gear. Thus, barring an unforeseen shock, I have concerns about the efficacy of further expanding the Fed’s balance sheet until our political authorities better align fiscal and regulatory initiatives with the needs of job creators. Otherwise, further quantitative easing might be pushing on a string. In the worst case, it could flood the engine of the economy with gas that might later ignite inflation.

I am afraid that despite recent speculation in the press and among market pundits, we did little at that meeting to settle the debate as to whether the Committee might actually engage in further monetary accommodation, or what has become known in the parlance of Wall Street as “QE2,” a second round of quantitative easing. It would be marked by an expansion of our balance sheet beyond its current footings of $2.3 trillion through the purchase of additional Treasuries or other securities. To be sure, some in the marketplace―including those with the most to gain financially―read the tea leaves of the statement as indicating a bias toward further asset purchases, executed either in small increments or in a “shock-and-awe” format entailing large buy-ins, leaving open only the question of when.

Since the FOMC meeting, a handful of my colleagues have fanned further speculation about QE2 by signaling their personal positions on the matter quite openly in recent speeches and interviews in the major newspapers. Hence the headline in yesterday’s Wall Street Journal, “Central Banks Open Spigot,”[3] a declaration that surely gave the ghosts of central bankers past the shivers and sent a tingle down the spine of gold bugs from Bemidji to Beijing.

...

However one may view the prominence of credit constraints for small businesses, it is unclear whether broad monetary actions will alleviate them; it might be more appropriate, perhaps, for the Treasury to undertake a targeted fiscal initiative to improve credit availability to small businesses. For mid- and large-sized nonfinancial firms, capital is fairly abundant in America, and it is unclear how much they would benefit from lowering Treasury interest rates.

An analysis of the current predicament in the United States leads one to conclude that while the risks of a double-dip recession are receding, the pace of the recovery is obviously subpar.

We are barely cruising above what we at the Dallas Fed call “stall speed.” Annual real gross domestic product (GDP) growth below 2 percent has predicated every recession since 1970. If we continue to barely clear the 2 percent hurdle, the pace of economic recovery will be insufficient to create the number of jobs the United States needs to bring down unemployment significantly in the foreseeable future. If we cannot generate enough new jobs to sufficiently absorb the labor force over the intermediate future, we cannot expect to grow the final demand needed to achieve more rapid economic growth.

Just as bookies in Vegas adjust their lines for the playoffs, the oddsmakers on the Street are constantly reassessing their positions regarding monetary policy. They change with new developments in the economy (the Fed’s Beige Book, for example, will be released tomorrow); with every public pronouncement of individual FOMC members; with insights proffered by the daily wire services and editorials in the Sunday editions of the nation’s finest newspapers (and good regional ones like your New York Times); and with the insights of consultants and analysts, some of whom even claim, spuriously, to have access to the internal deliberations of Federal Reserve policymakers. But until the committee meets, nothing is decided.

[T]o paraphrase the early 20th century progressive Clarence Day―the once-ubiquitous contributor to my favorite magazine, The New Yorker―“Too many (theorists) begin with a dislike of reality." The reality of fiscal and regulatory policy inhibiting the transmission mechanism of monetary policy is most definitely present and is vexing to monetary policy makers. It is indisputably a significant factor holding back the economic recovery.

[I]f fiscal and regulatory authorities are able to dispel the angst that businesses are reporting and put together a credible plan for deficit reduction that does not choke off growth, further accommodation might not even be needed. If job-creating businesses are more certain about future policy and are satisfactorily incentivized, they are more likely to take advantage of low interest rates, release the liquidity they are hoarding and invest it robustly in hiring and training a workforce that will propel the American economy to new levels of prosperity. This would render moot the argument for QE2, or a second round of quantitative easing. The key is to remove or reduce the tax and regulatory uncertainties that act as an impediment to businesses as they respond to increases in final demand. I think most all would consider this to be a far more desirable outcome than being saddled with a bloated Fed balance sheet.

Given that we operate under a dual mandate, Congress might insist we also have an employment-level target [in addition to price-level targeting]. Personally, I would be happy with an inflation target, but I don’t think Congress would tolerate it.

To me, the key to crafting monetary policy is placing the theoretical analysis―done by our able staffs of economists using quantitative modeling―within the qualitative context of economic behavior as practiced by businesses, consumers, investors and other players actually operating in the field.

In sum, I asked that the FOMC consider that we might be prescribing the wrong medicine for the ailment from which our economy is suffering. Liquidity and abundant money are not the binding constraints on the economic activity we wish to see. The binding constraints are uncertainty about income and future aggregate demand, the disincentives fiscal and regulatory policy impose on ridding decisionmakers of that uncertainty, and the reluctance, given those disincentives, of those who have the power to create jobs for our people to invest in undertakings that would create them.

The remedy for what ails the economy is, in my view, in the hands of the fiscal and regulatory authorities, not the Fed. I could not state with conviction that purchasing another several hundred billion dollars of Treasuries—on top of the amount we were already committed to buy in order to compensate for the run-off in our $1.25 trillion portfolio of mortgage-backed securities—would lead to job creation and final-demand-spurring behavior. But I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed.

My perspective, as with those of all other members of the FOMC, was given a thoughtful and fair hearing at the table. After deliberation, the majority of the committee concluded that under current and foreseeable conditions, the better approach was to purchase $600 billion in Treasuries between now and the end of the second quarter of next year, on top of the amount projected to replace the paydown in mortgage backed-securities. The math of this new exercise is readily transparent: The Federal Reserve will buy $110 billion a month in Treasuries, an amount that, annualized, represents the projected deficit of the federal government for next year. For the next eight months, the nation’s central bank will be monetizing the federal debt.

This is risky business. We know that history is littered with the economic carcasses of nations that incorporated this as a regular central bank practice. So how can the decision made last Wednesday be justified?

It concerns me that liquidity is omnipresent on bank and corporate balance sheets, and yet it is not being used to hire American workers.

It also concerns me that the most recent Lipper/AMG financial market data show year-to-date flows into virtually all asset classes except money market funds. The flows are strong into every category: high-risk to low-risk bond vehicles, taxable and nontaxable, domestic and external, fixed and floating rate, and, of course, commodities. Margin debt remains shy of 2007 highs but is fast approaching levels that prevailed before the NASDAQ implosion in 2001; in fact, margin-account debit balances as a percentage of the market capitalization of the S&P 500 now exceed the precrash level of 1987 and 2001.

Junk yields are at their lowest levels since October 2007. And the leveraged buyout market is back to paying 2006 levels of EBITDA (earnings before interest, taxes, depreciation and amortization) of 6 to 8.5 times, with the recent announcement of Carlyle Group’s reported 11 times EBITDA purchase of Syniverse Holdings echoing the peak of the precrash craze. As you know, buyout people do not typically acquire companies with a plan to expand the workforce, but instead with an eye to tighten operations, drive productivity, rejigger balance sheets and provide an attractive payback, usually in shorter time than under normal corporate horizons. And the corporations I talk to that are eyeing possible acquisitions with their surplus cash and ready access to the credit markets are not given to thinking of strategic acquisitions as a way to expand payrolls.

In sum, scanning the business landscape and the conditions of the financial markets, I concluded as a golfer that the greens are playing very fast and must be approached with great caution. At a minimum, I concluded, the committee would need to be very careful in how we calibrated our next strokes, lest we overplay it.

I fully understand the theoretical impulse to drive long-term interest rates to lower levels in hopes of stimulating loan demand and challenging the propensity for economic actors to hoard rather than invest. Given that foreign exchange markets react to interest rate differentials between countries, one effect of engineering lower rates would be to devalue the dollar, presumably to create demand for exports. The ultimate objective would be to advance final demand, generate employment for American workers and revive output.

Dallas Fed President Richard Fisher, speaking to reporters after a townhall-style event with local business leaders in this central Texas town, said he wants the dollar to be more than "the best horse in the glue factory."

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we have reached our limit. I would be wary of further expanding our balance sheet

From an interview in the Dallas Morning News,  (The interview was conducted before the January FOMC blackout period began.)

In November, the Federal Reserve launched a $600 billion program to buy up longer-term U.S. Treasury debt, describing the plan as a way to promote a stronger pace of economic recovery.

Dallas Fed President Richard Fisher — a member of the Fed committee that formulates monetary policy — publicly opposed the plan and says he would have voted against it “had I had the vote.”

...

Plosser and Fisher are both seen as potential dissenters. Last week, Plosser said the Fed’s easy money approach could backfire by stoking inflation. Fisher told The News that he expects the bond-buying program to run its course, adding that he “would be wary of further accommodation.”

But dissent is not the goal, said Fisher, who dissented four times in 2008.

“I’m not itching to dissent,” he said.

You can never say never, but I cannot imagine a convincing argument for further quantitative easing after this round, given what is developing now in the economy.

The entire FOMC knows the history and the ruinous fate that is meted out to countries whose central banks take to regularly monetizing government debt. Barring some unexpected shock to the economy or financial system, I think we are pushing the envelope with the current round of Treasury purchases. I would be very wary of expanding our balance sheet further; indeed, given current economic and financial conditions, it is hard for me to envision a scenario where I would not use my voting position this year to formally dissent should the FOMC recommend another tranche of monetary accommodation. And I expect I will be at the forefront of the effort to trim back our Treasury holdings and tighten policy at the earliest sign that inflationary pressures are moving beyond the commodity markets and into the general price stream. I am a veteran of the Carter administration and know how easily prices can spin out of control and how cruelly markets can exact their revenge. I would not want to relive that experience.

The new Congress and the new staff in the White House have their work cut out for them. You cannot overstate the gravity of their duty on the economic front. Over the years, their predecessors―Republicans and Democrats together―have dug a fiscal sinkhole so deep and so wide that, left unrepaired, it will swallow up the economic future of our children, our grandchildren and their children. They must now engineer a way out of that frightful predicament without thwarting the nascent economic recovery.

I have been outspoken about the limits of monetary policy as a salve for the nation’s fiscal pathology. The Fed has done much, as I see it, to provide the bridge financing until the new Congress gets to work restructuring the tax and regulatory incentives American businesses need to confidently expand their payrolls and capital expenditures here at home.

The Fed has done its job... It’s now up to fiscal authorities to make it work.

Indeed, as a voting member of the FOMC this year, I have made clear within the meeting room and in public speeches that, barring some frightful development, I will vote against any program that might seek to extend or enlarge the substantial monetary accommodation we already have provided, just as I argued against the $600 billion extension the voters on the Committee approved last November. And I remain doubtful enough as to its efficacy that if at any time between now and June, it should prove demonstrably counterproductive, I will vote to curtail or perhaps discontinue it. As I said, the liquidity tanks are full, if not brimming over. The Fed has done its job. What is needed now is for business to be incentivized to commit that liquidity to creating American jobs. This is the task of the fiscal authorities, not the Federal Reserve.

I was quoted in the Washington Post on Feb. 21 as saying that we had suffered for too long from “Lindsay Lohan” Congresses.[6] Like Ms. Lohan, the American Congress is a beautiful creation, blessed with enormous talent. But it has been waylaid by addiction—in the case of the Congress to spending and debt―and by a proclivity for shoplifting―in the case of the Congress to pocketing for their immediate gratification the economic future of our children and grandchildren and our grandchildren’s children.

Fisher said he is "beginning to see signs of speculative excess" in the U.S., evidenced in the "fresh flow of money" into the stock market, a surge in so-called covenant-lite loans and the re-leveraging by private equity firms.   "There’s lots of liquidity sloshing around the U.S. financial system," Fisher said. "We are seeing signs of all the intoxication that typically takes place when we have the ambrosia of cheap and readily available capital."

.....

"No further accommodation is needed after June," including by tapering the central bank’s purchases, the regional bank chief, who votes on monetary policy this year, said in a speech today in Frankfurt. "Doing so would only prolong the injustice that we have inflicted" on savers through inflation, he said.

As reported by Bloomberg News

No amount of forthcoming accommodation... will help the process which is afflicting the United States right now and may well make it worse. The problem afflicting the United States right now is that Americans are out of work.

[The Fed] “opened the floodgates” and “it worked,” the regional bank chief, who votes on monetary policy this year, said during a speech today in Dallas. “We re- liquefied the economy. In my opinion, we might have done too much."

There are perceptional risks, for example. Our duty is most distinctly not to monetize―or even be perceived as monetizing―the debt of fiscally imprudent government. Throughout the history of nations, monetizing the budgetary excesses of governments has proven to be a direct path to economic perdition. Having already peeked inside that door, I feel strongly that we must now shut it, lock it and throw away the key.

...

Continued accommodation presents significant risks. In my view, no amount of further accommodation by the Fed would be wise—either by prolonging or “tapering off” the volume of purchases of Treasuries past June, or adding another tranche of large-scale asset purchases. Indeed, it may well be that we should consider curtailing what remains of QE2.

Now, we at the Fed are nearing a tipping point. Just as we pressed on in doing our duty through extraordinary, exigent measures, we must now discipline ourselves to just as persistently normalize our operations in a timely way.

The Fed’s interventions to drive interest rates to historically low levels resulted in significant capital gains for bondholders and equity investors in the most plain-vanilla securities and mutual funds. Yet, by taking interest rates to zero and making money cheap and abundant so as to reliquefy the economy, those who invested the most conservatively―tucking their savings away in the safest of vehicles, like CDs, money market funds, and Treasury bills and notes―saw the income earned on their hard-earned savings dramatically reduced.

I personally fret over these and other costs, but on net, I believe the Federal Reserve did what is expected of a responsible central bank: We stemmed a panic and averted a depression.

Fisher, who has criticized the Fed’s asset purchase program and expressed concern about rising prices, said the central bank has “successfully fought off” deflation.

“There is a lot of liquidity in the system,” Fisher said.

"I fully expect I will be at the front of the pack for advocating for tightening but you don't tighten until you have stopped loosening and we are still in the loosening process," Fisher told reporters.

Fisher, who has been a vocal critic of the current course of monetary policy, also said the Federal Reserve has not agreed yet on a sequence of events in which it would start its exit strategy from hyper-loose monetary policy. He said there have been discussions on several options. "We really didn't lay out a sequence, we are having a discussion on an exit strategy and we have been having those discussions for quite some time," he said.

While there is much to criticize about Dodd–Frank, I cotton to those blunt statements on ending too big to fail. For, if after the myriad rules and regulations are written and implemented we have not eradicated too big to fail from our financial infrastructure, reform will have failed yet again.

I am personally just pleased that we're done with this large-scale asset purchase program.  It ends in June.  I am personally not able to envision a scenario where we would do more because there's lots of liquidity in the system.

We are lean and mean.  Our balance sheets are in great shape in America.  There is a lot of liquidity out there.  I am eager to see the trigger, and I don't know what it is for that money to be spent putting Americans back to work, committing to capital expansion.  It's jobs and unemployment.  American businesses are in very, very good shape.

I think businesses are going to have a tough time pricing what goes out the door to make up for what comes in the door.  We know that pressure is there.  We'll have to see if the consumer will allow them to get away with it.

“The worst outcome of all would be for the Fed to continue monetizing the debt,” Fisher, 62, said today during a speech in Dallas. “We’ve been doing that since November.”

“We’ve done enough,” Fisher said in a speech to the Chartered Financial Analysts Society of Dallas-Fort Worth. “I will not support our doing more.”

“It wouldn’t be unimaginable to see 4 percent growth in the second half” of 2011, Fisher said today in a speech in Round Rock, Texas. “The price of energy and price of food has frightened the consumer,” he said. “As these prices come down a little, as we forecast they would, that relieves a little bit of the anxiety.”

“I look forward to exiting from accommodative monetary policy,” Fisher told reporters, while declining to say when an exit might take place. “The question is timing.” Holding the balance sheet steady after June is a “first step.”

“We’ve exhausted our ammunition, in my view” and expanding the Fed’s balance sheet from about $2.7 trillion to more than $3 trillion “might spook the marketplace,” he said.

“I do not personally see the benefit of more monetary accommodation even if the economy weakens further,” Fisher said. “Again, there’s so much liquidity out there, the question is, ‘What is the trigger to put it to work?’”

I was also concerned that just by tweaking the language the way the committee did, our action might be interpreted as encouraging the view that there is an FOMC so-called “Bernanke put” that would be too easily activated in response to a reversal in the financial markets.

My long-standing belief is that the Federal Reserve should never enact such asymmetric policies to protect stock market traders and investors. I believe my FOMC colleagues share this view.

Inflation is not the issue presently.... We don’t have dramatic amounts of inflation. I think we’re trending more toward 2 percent.

We want to make sure we’re not pushing on a string... Money is basically free, gas tanks are full. Who steps on the gas pedal? Who engages the transmission?

If I believe further accommodation or some jujitsu with the yield curve will do the trick and ignite sustainable aggregate demand, I will support it. But the bar for such action remains very high for me until the fiscal authorities do their job, just as we have done ours. And if they do, further monetary accommodation may not even be necessary.

Both within the FOMC and in public speeches, I have argued that until our fiscal authorities get their act together, further monetary accommodation―be it in the form of quantitative easing or performing “jujitsu” on the yield curve through efforts such as Operation Twist―will represent nothing more than pushing on a string.

“We’re seeing a flight to quality,” said Fisher, who called the U.S. “the best-looking horse in the glue factory.”

Federal Reserve Bank of Dallas President Richard Fisher said the central bank has “plenty of ammunition” left if the economic situation turns “horrific,” while reiterating his view the Fed has provided enough stimulus.

If I believed further accommodation or fiddling with the yield curve would do the trick and ignite sustainable aggregate demand, I would support it. But the bar for such action remains very high for me until the fiscal authorities do their job by reducing the fiscal and regulatory uncertainty that is holding our mighty economy back.

Another Fed dissenter, the Dallas Fed's Richard Fisher, opposed Tarullo's suggestion of further mortgage bond buys. "I am not similarly inclined," he told reporters.

Kenneth Arrow, a Nobel Laureate in economics, had his own perspective on forecasting. During World War II, he served as a weather officer in the U.S. Army Air Corps and worked with a team charged with the particularly difficult task of producing month-ahead weather forecasts. As Arrow and his team reviewed these predictions, they confirmed statistically what you and I might just as easily have guessed: The corps’ weather forecasts were no more useful than random rolls of a die. Understandably, the forecasters asked to be relieved of this seemingly futile duty. Arrow’s recollection of his superiors’ response was priceless: “The commanding general is well aware that the forecasts are no good. However, he needs them for planning purposes.”

I happen to believe that the Federal Reserve is exhausting the limits of prudent monetary policy. The programs popularly known as QE2 and Operation Twist are, to my way of thinking, of doubtful efficacy, which is why I have not been able to support them. I suspect that, at least in the case of Operation Twist, they have so far been of greater benefit to traders and large monied interests than to job-creating businesses. But even if you believe, as the majority of my learned colleagues do, that the benefits of QE2 and Operation Twist outweigh their costs, you would be hard-pressed to now say that still more liquidity, or more fuel, is called for given the $1.5 trillion in excess bank reserves and the substantial liquid holdings businesses are hoarding above their normal working-capital needs.

"We have already set that precedent," he said. "We are reallocated within that existing portfolio, which is an expanded balance sheet way above the $800 billion which is the norm for our central bank. And I would be very wary of more accomodation. There is plenty of liquidity."

You can give people all the money they want -- which we have done ... They won't use it unless they have confidence in the future. And that future is being undermined by oyur fiscal authorities.

“As we get into other securities -- we are in mortgage- backed securities in a big way and we lengthened our activity along the yield curve -- then we’re going outside our normal purview,” Fisher said. “I do think it behooves us to think of what risks that presents.”

“I’m more comfortable now in terms of not -- this is me personally speaking -- not anticipating greater accommodation,” he said yesterday in an interview at Bloomberg’s headquarters in New York. “The direction we’re moving in is positive.”

“I believe that too-big-to-fail banks are too-dangerous- to-permit,” Fisher said in the text of remarks given in New York today. “Downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response. Then, creative destruction can work its wonders in the financial sector, just as it does elsewhere in our economy.”

“No one wants to see 9 percent official unemployment and the extensive underemployment,” Fisher said. Businesses are “in a defensive crouch,” he said. “We are in a stasis.”

“We need to completely reboot our fiscal policy,” Fisher said. “We have to compete in terms of our tax regimes and the incentives we provide for business.”

“Running the printing presses to pay today’s bills leads to much greater problems,” including a surge in inflation. “We will never let that happen at the Federal Reserve, never,” Fisher said. “Stable prices go hand in hand with achieving sustainable growth.”

My reluctance to support greater monetary accommodation has been based on efficacy.

For me, explicitly acknowledging that monetary policy’s impact on employment is transitory and uncertain is a cardinal event. It signals to the markets that there are limits to the ultimate job-stoking efficacy of Federal Reserve policy. To the extent that inflation is running below 2 percent, the Federal Reserve may have somewhat greater latitude to pursue accommodation. However, the past few years have demonstrated, yet again, that allowing inflation to rise by no means guarantees faster job growth. The message to our nation’s fiscal authorities is that they cannot expect monetary policy to substitute for the need to get their act together, stop their shameful politicking, get on with putting their fiscal and regulatory house in order and do so in a manner that encourages rather than continually undermines job creation and economic expansion.

My predecessor at the helm of the Dallas Fed, Bob McTeer, used to say, “The first rule of forecasting should be ‘don’t do it.’” The second rule, he would add is, “If you give a number, don’t give a date.” But given the assignment to venture a vision as to where the fed funds rate would be in each of the next three years and over “the longer run” to the nearest one-quarter of one percent, the 17 intrepid souls of the FOMC, including yours truly, did so. Only three envisioned that the fed funds rate might rise from current levels by year-end 2012; six saw it doing so by year-end 2013 and 11 by year-end 2014. Over the longer term, the 17 members envisioned a funds rate of between 3¾ and 4½ percent.

Bob McTeer’s admonishment clearly does not resonate with the FOMC. And yet I would caution, again, that at best, the economic forecasts and interest-rate projections of the FOMC are ultimately pure guesses. I have yet to find a single economist on this planet who consistently forecasts the economy accurately, let alone projects with any precision the interest rate on overnight funds one year out or far into the future. If you examine the record of the Blue Chip economists or even of our superb Federal Reserve staff, you will find confirmation of a paucity of reliable economic forecasts.

"There will be no QE3," Dallas Fed President Richard Fisher told reporters after a speech here. "I will support no QE3, no additional mortgage-backed securities, no additional Treasuries."

"Wall Street keeps dangling QE3 out there," Fisher said. "I think it's a fantasy of Wall Street - it's not going to happen, it's not necessary."

“I thought the statement was talking down the economy” amid recent improvement, Fisher said. He said he views the 2014 pledge as “that rates will stay low for as long as it is practicable,” or “until we see improvement in the economy.”

“The power of the five largest banks is too concentrated,” he said. "The banks have become larger since the 2008 financial crisis and are now ‘too bigger to fail.’”

I might add that I am personally perplexed by the continued preoccupation, bordering upon fetish, that Wall Street exhibits regarding the potential for further monetary accommodation—the so-called QE3, or third round of quantitative easing. The Federal Reserve has over $1.6 trillion of U.S. Treasury securities and almost $848 billion in mortgage-backed securities on its balance sheet. When we purchased those securities, we injected money into the system. Most of that money and more has accumulated on the sidelines: More than $1.5 trillion in excess reserves sit on deposit at the 12 Federal Reserve banks, including the Dallas Fed, for which we pay private banks a measly 25 basis points in interest. A copious amount is being harbored by nondepository financial institutions, and another $2 trillion is sitting in the cash coffers of nonfinancial businesses.

Trillions of dollars are lying fallow, not being employed in the real economy.

Financial market operators keep looking and hoping for more. Why? I think it may be because they have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery, rescuing the economy from the Financial Panic of 2008–09, and then kept the medication in the financial bloodstream to ensure recovery. I personally see no need to administer additional doses unless the patient goes into postoperative decline. I would suggest to you that, if the data continue to improve, however gradually, the markets should begin preparing themselves for the good Dr. Fed to wean them from their dependency rather than administer further dosage.

"You know, I am a hawk on inflation. But that is, inflation has been coming down, not going up,” Fisher said. “I watch this like a hawk, because this is my little part of the aviary at the Federal Reserve system. I’m perched, ready to pounce on inflation. I don’t see that as the problem presently.”

“I am personally not arguing at the table or publicly that we should be tightening right now,” Fisher told reporters after his speech today. “Before you tighten you have to stop accommodating and I don’t believe we need further accommodation.”

I’m just reporting what I hear on the street, which is a real concern that with our expanded balance sheet, we are just a little bit in an ember of what could become an inflationary fire.

"There's so much liquidity in the system," Fisher said. "Why would we add more unless we had a crisis on our hand or something was happening where we're seeing significant slippage in the economy?"

By providing monetary accommodation, we’re saying, in essence, Congress, you better eat your vegetables, or we’ll serve you a big plate of monetary cookies.

There is in the marketplace a lingering fear that the Fed has already expanded its balance sheet to its stretching point and that an exit strategy, though articulated, remains theoretical and untested in practice. And there is a growing sense that we are unwittingly, or worse, deliberately, monetizing the wayward ways of Congress. I believe that were we to go down the path to further accommodation at this juncture, we would not simply be pushing on a string but would be viewed as an accomplice to the mischief that has become synonymous with Washington.

"I'm not yet ready to advocate an exit strategy," Dallas Federal Reserve Bank President Richard Fisher told reporters after a speech on the Texas economy in Dallas. "We have to stop accommodating first."

“You can reach a size where risk management becomes an exercise,” Fisher said today in response to audience questions following a speech to the Texas Bankers Association meeting in Fort Worth. “At what point do you reach a size you don’t know what is going on beneath you?”

“That is not the American form of capitalism,” Fisher said. “We are calling for significant downsizing of those institutions. We don’t feel the Dodd-Frank Act is the answer to the problem.”

“We pray for the big risk management teams in those big New York banks,” the Dallas Fed chief said.

"I don't hear any business people and job creators saying, 'I need more liquidity, I need more money,'" Dallas Fed President Richard Fisher told reporters after a speech here. Even though inflation is not currently a threat, "I don't see what we would accomplish with further accommodation."

There is in the marketplace a lingering fear that the Fed has already expanded its balance sheet to its stretching point and that an exit strategy, though articulated, remains theoretical and untested in practice. And there is a growing sense that we are unwittingly, or worse, deliberately, monetizing the wayward ways of Congress. I believe that were we to go down the path to further accommodation at this juncture, we would not simply be pushing on a string but would be viewed as an accomplice to the mischief that has become synonymous with Washington.

“We face a very real risk of having formidable competitors to the dollar in the sweepstakes for sovereign investment,” Fisher said today in remarks prepared for a speech in La Jolla, California. “As Chinese policy makers lay the groundwork for the continued internationalization of the renminbi, our nation’s fiscal authorities must bear in mind that there may one day be viable alternatives to the dollar and U.S. Treasury debt.”

"There’s a limit to what we can do without distorting the marketplace."

"The real question is: Where does it start to interfere with the way that markets allocate securities?"

"My suspicion is Operation Twist is having a very minor effect” and “the costs exceed the benefits. That’s why I personally didn’t support the program."

Richard Fisher.... said the real problem with the economy, and the stubbornly high jobless rate, is Congress's lack of action on fiscal policy.

Fisher, who spoke to Reuters roughly six weeks ahead of a Fed policy meeting that many see coming at a critical juncture, said any perceptions that the U.S. central bank could be motivated by political factors are untrue -- but the Fed must guard against any misimpressions.

If the Fed launches another round of easing, Fisher said, "Those that do not like us as central bankers I think will be apoplectic."

“We’re at the risk of overburdening the central banks” and “we keep applying what I call monetary Ritalin to the system. We all know there’s a risk of overprescribing.”

"We have done our job. We have done enough. Just doing more does not solve the problem. The problem is engaging the transmission. We provided the gas. The gas tank is full. Who will incent the driver of this economy to step on the accelerator and move it forward? That is the private sector.”

"My point is that we have so much extra cash and reserves sitting on the sidelines, it is not being put to work right now. The question is: what will incent people to use the copious amounts of money we put out there and step on the accelerator and move job creation forward when we have the fiscal policy uncertainty? I think we’re pushing on a string. It is a great risk that I am not only worried about, but the Bank for International Settlements wrote their entire annual report and concluded we are at the risk of overburdening the central banks.”

"The time to do more would have been in August. I disagree with that policy, but if you’re going to do it, we should have done it. The closer we get to an election, the more I think the perception incorrectly will be that we have become too politically pliant. So there’s a lot of downside here and the question is, for what upside?”

"There's no uncertainty about one thing - there's plenty of cheap high-octane fuel which we the Fed have provided," Fisher said. "What good would it do to put still more out there since what we've already put out there is not having much effect on employment?"

Fisher said further Fed action could actually hurt a recovery already only at stall speed by fueling uncertainty "if people feel we are going too far.

 “I question the efficacy of these large-scale asset purchases,” Fisher said. “What we are doing is not having the impact on employment.”

I felt an urge at the meeting last week to tie the chairman to the mast, Odyssean-style, and to stuff wax in the ears of my fellow committee members, in order to resist the Siren call of further large-scale asset purchases.

But I have no such powers.

The fix lies not within the purview of the Federal Reserve. The fix lies solely in the hands of a government that has the power to shape taxes and spending programs to incent businesses to go out and hire rather than ball up into a defensive crouch, or worse, go elsewhere in the world that we worked so hard to liberate, to create jobs for others rather than for our own people.

The private sector and American business community are poised to expand. But they will not do so as long as we have a government that cannot resist the temptation to devise a politically convenient patchwork instead of laying out a convincing, reliable, long-term program that job creators and consumers can count on and plan around.

The Federal Reserve has been carrying the ball for the fiscal authorities by holding down interest rates in an attempt to stoke the recovery while the fiscal authorities wrestle themselves off the mat. But there are limits to what a monetary authority can do. For the central bank also plays a fiduciary role for the American people and, given our franchise as the globe’s premier reserve currency, the world. We dare not become the central bank counterpart to Congress by adopting a Buzz Lightyear approach of “To infinity and beyond!”

The Fed could announce a limit as to how much we are going to acquire of treasuries and mortgage-backed securities, say up to a limit of X, up to a point where our balance sheet reaches that, Fisher said today in Berlin. It is my personal preference to do it sooner than later, perhaps at the next meeting.

"There is no such thing as QE infinity, he said. QE infinity gets you into trouble."

"I argued that basically we were at risk of what I call a 'Hotel California' monetary policy," Fisher said in an interview with CNBC, referring to an Eagles song about a hotel from which one can never leave. "Theoretically we can check out any time we want from this program, but practically, since we're going to have an engorged balance sheet, we may never be able to leave this position."

Since September, hardly a trading day goes by without a company announcing a new debt offering to take advantage of today's historically low interest rates to finance further share buybacks and/or special dividend payouts. Too little of this money is being used to invest in job creation and job-creating expansion of plant and equipment in the U.S. Which raises a question about the efficacy of our accommodative monetary policy: Are our massive purchases of Treasury notes and bonds effective in meeting our mandate of conducting monetary policy so as to create maximum employment?

The answer is, quantitative easing is a necessary but insufficient tool to spark job creation. Employers will not deploy the cheap and abundant capital on hand toward job creation while there is so much uncertainty surrounding final demand for the goods and services they sell.

We have a ranch in Franklin County in East Texas. We have a 2,200-pound bull there that breeds our Longhorn cows. His name, incidentally, is "Too Big to Fail."

Now, Too Big has plenty of liquidity at his disposal; he's fully equipped to do what we want him to do. But if we put him on the opposite side of the fence from those pretty cows, he's unable to perform. Think of the uncertainty I've just spoken of, and especially the uncertainty surrounding the resolution of the fiscal cliff, as a fence. Businesses, just like Too Big, have plenty of liquidity; they have the resources they need to do what we want them to do—in this case, invest in job creation. But as long as that fence of uncertainty is in place, they will not be able to perform.

Richard Fisher, president of the Federal Reserve Bank of Dallas, said he favors reducing the pace of central bank asset purchases as the U.S. economy gains momentum this year.

“As you approach your goals and things get better, you reduce purchases,” Fisher said in an interview with Kathleen Hays on Bloomberg Radio’s “The Hays Advantage.” “I wouldn’t go from Wild Turkey to cold turkey” in monetary stimulus. “I wouldn’t have favored spiking the punch bowl to the degree we have,” though it would be too abrupt to stop purchases all at once.

Fisher, who doesn’t vote on monetary policy this year, said he opposed the Federal Open Market Committee decision last week to continue purchasing securities at the rate of $85 billion a month. Policy makers have pushed the benchmark interest rate close to zero and expanded Fed assets to more than $3 trillion to spur growth and reduce unemployment.

Fisher said he agreed with St. Louis Fed President James Bullard, who said Feb. 1 he expects the U.S. economic expansion to pick up enough to allow the Fed to reduce purchases by the middle of the year. A reduction in purchases could be motivated by either an assessment that quantitative easing hasn’t been effective or that the economy gained momentum, the Dallas Fed leader said...

“I would not advocate just stopping the program,” he said. Slowing purchases “allows the market to adjust.”

“I’m personally in favor of tapering back our mortgage- backed security purchases,” Fisher told reporters today at a conference in Abu Dhabi. “I think we’ve assisted the recovery of the housing market. We have a pretty robust housing situation right now. We don’t want to slip backwards."

As reported by Bloomberg News

The analogy I like to use is that of Ritalin or Adderall.  You can condition and motivate the behavior by applying that kind of drug, but there are also dangers to overprescribing it.  It doesn't go on forever because you can kill the patient.

It is not yet clear that we will achieve a justifiable bang for the trillions of bucks the Fed has flooded the economy with. Only time will tell if the efficacy of quantitative easing we have undertaken was justifiable in regard to job creation and delivering on the second component of our dual mandate.

“It would be prudent to dial back the rate of purchases we are making in mortgage-backed securities” now that “the housing market is in a good state, construction has started again, housing prices are appreciating significantly.”

But I do believe that big money does organize itself somewhat like feral hogs. If they detect a weakness or a bad scent, they’ll go after it.

...

My personal feeling is that you don’t walk up to a lion and flinch.

He said the Fed statement and subsequent press conference were part of a process to prepare markets for the end of central bank support. It “made sense to socialise the idea that quantitative easing is not a one-way street”, he said, and emphasised any such move would be done cautiously.

The efficacy of this effort is the subject of significant debate, even internally within the FOMC. Some who question the efficacy, including myself, note that the effect of our purchasing MBS and driving down mortgage rates has certainly assisted a robust recovery in housing, and with it, construction jobs and manufacturing and transportation of materials that go into homes… [T]he Fed’s muscling of the yield curve has brought what has been a 30-year-long bond market rally to a crescendo…

Counteracting whatever benefits one can trace to the Fed’s unorthodox policies are some obvious costs. First, savers and others who rely on retirement monies invested in short-maturity fixed-income investments, such as bank CDs and Treasury bills, have seen their income evaporate while the rich and the quick, the big money players of Wall Street have become richer still.

Second, the standard return assumptions of 7.5 to 8 percent for retirement pools, as you well know, have been dashed (though I have always felt they were already calculated on an imaginary and politically convenient basis rather than a realistic one).

Third, accompanying the Fed’s growing balance sheet we have seen a dramatic expansion in the monetary base—the sum of reserves and currency. A basic understanding of demand-pull inflation is “too much money chasing too few goods.” Thus, the excess, currently nondeployed money could prove the kindling of an inflationary conflagration unless the Fed is nimble in managing its effect as it works its way into the economy’s production and consumption of goods and services.

A corollary of reining in this massive monetary stimulus in a timely manner is that financial markets may have become too accustomed to what some have depicted as a Fed “put.” Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital.

…

Whereas before, our portfolio consisted primarily of instantly tradable short-term Treasury paper, now we hold almost none; our portfolio consists primarily of longer-term Treasuries and MBS. Without delving into the various details and adjustments that could be made (such as considerations of assets readily available for purchase by the Fed), we now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS.

The point is: We own a significant slice of these critical markets. This is, indeed, something of a Gordian Knot…

There is no Alexander to simply slice the complex knot that we have created with our rounds of QE. Instead, when the right time comes, we must carefully remove the program's pole pin and gingerly unwind it so as not to prompt market havoc. For starters though, we need to stop building upon the knot. For this reason, I have advocated that we socialize the idea of the inevitability of our dialing back and eventually ending our LSAPs. In June, I argued for the Chairman to signal this possibility at his last press conference and at last week’s meeting suggested that we should gird our loins to make our first move this fall. We shall see if that recommendation obtains with the majority of the Committee.

(As an aside, if you look at a dollar bill you can see by the letter printed to the left of George Washington which Federal Reserve District it originally came from: Those with an “L” are the ones ordered from the Bureau of Engraving and Printing by the San Francisco Fed for Oregon and other states that make up the Twelfth Federal Reserve District; those with a “K” are from the Dallas Fed’s Eleventh District, covering principally Texas—these, of course, are the most coveted!)

“If you’re asked to do something by the president of the United States, it’s very hard to turn it down, but I won’t be asked,” Fisher said. “I think the odds are zero.”

Why? “I have a very defined profile, and it may not be in keeping with the style the president is looking for,” he said. “There’s probably not a stylistic fit.”

But still, the TBTF behemoths were indisputably what the Bank of England’s Andy Haldane called “super-spreaders” of the virus that brought our financial system and economy to its knees.[10] They retain that potential today. For in the aftermath of the crisis and the passage of Dodd–Frank, the giants have gotten bigger, and the profitability of the community and regional banks that might pose meaningful, healthy competition has been undermined by the legislation’s complexity.

Dodd–Frank claims to end TBTF. Instead, as the Wall Street Journal editorialized, it entrenches the TBTF pathology. The megabanks remain a potential lethal force. As mentioned, I will be speaking at length on this subject in New York in October.

Today, I will simply say that I disagreed with the decision of the committee and argued against it. Here is a direct quote from the summation of my intervention at the table during the policy “go round” when Chairman [Ben] Bernanke called on me to speak on whether or not to taper: “Doing nothing at this meeting would increase uncertainty about the future conduct of policy and call the credibility of our communications into question.” I believe that is exactly what has occurred, though I take no pleasure in saying so.

My point is simply to highlight the longer-term consequences of what might appear to be smallish, shorter-term deviations from the norm. Business operators plan capital expenditure and payrolls not in one- or two- or even three-year increments; they plan and budget over longer-term horizons. The nominal stability that people need if they are going to negotiate multiyear contracts is a multiyear nominal stability. A policy that “lets bygones be bygones” from year to year may not achieve this kind of stability, especially when policy options can become constrained, in the short term, by the zero bound. A policy that takes a longer-term perspective and is properly communicated and executed—so as to instill confidence that monetary policy will hew to a 2 percent inflation target rather than fixate on the run-rate of the past four quarters or the outlook for the next four—may better supply the longer-term comfort that households and businesses need to plan and budget. Such a policy would reduce the uncertainty that monetary policy as it is currently conducted spawns and would be more effective in doing its part to assist in economic expansion.[9]

[For more information about tightening control of inflation expectations by putting a five-year inflation rate, in place of the usual four-quarter inflation rate, in the Taylor rule, see “All in the Family: The Close Connection Between Nominal-GDP Targeting and the Taylor Rule,” by Evan Koenig, Federal Reserve Bank of Dallas Staff Papers, No. 17, March 2012.]

In short, while the Fed has been moving at the speed of a boomer in full run, the federal government of the United States has at best exhibited the adaptive alacrity of a koala (without being anywhere near as cute).

(President Fisher supplied a footnote explaining that “boomer” is Australian slang for kangaroo.)

“I would say in terms of my own support, that I wouldn’t rule out my supporting doing something {on tapering} before March.

…

“I think at the earliest possible moment we need to focus on transitioning back to having an interest rate-driven monetary policy,” he said.

“I can envisage us holding the base rate low for a very long time until we see an acceleration in the economy and especially in our case given our mandate on employment, as long as inflation stays in its current range, at less than 2 percent,” Fisher said.

As was mentioned by Stephen, I am indeed half Aussie. My father, Leslie Fisher, was a Queenslander. In 1910, at the age of five years and two months, he was arrested for begging on the streets in Maryborough and sentenced in the court there to seven years in the Westbrook Reformatory.[1]

According to an article earlier this year in Toowoomba’s daily, The Chronicle, Westbrook was “the most feared reformatory in Australia.” The guards there meted out “vicious beatings.”[2] Thankfully, my father’s sentence was commuted after one month; “the little boy … is of tender years and not a fit subject,” wrote the Police Magistrate. My father was released to an orphanage, then shuttled among a series of harsh foster homes before making his way back to the streets and a remarkable career that took him from Toowoomba to Brisbane to South Africa, Mexico, China and the United States and, ultimately, to … the great republic of Texas!

My dad lived to the ripe old age of 90. He was a tough old bird. And Aussie to the bone. For most of his life, he smoked three packs of cigarettes a day and drank a great deal of Scotch. He admitted to this one evening and a friend said, “Hold on. My father was a smoker and also drank a lot of Scotch. But he died at 60. What gives?” To which my father replied, “Well, he just didn’t do it long enough.”[3]

The Westbrook prison is no more; indeed, the property on which it stood was sold in May of this year. But the courthouse in Maryborough where my father was sentenced still stands. On Wednesday, I will visit it to remind myself of where I come from. And to thank my lucky stars that I am the son of a gutsy Australian who managed in one generation to secure his family’s rise from homeless to Harvard, from begging for food to riches, from being a ward of the state to becoming a principal in the policymaking of the most important central bank in the world.

I used to say that the United States was the best-looking horse in the global glue factory. Now, I firmly believe we are the most fit stallion or filly on the global racetrack: Our companies are the most financially prepared and most productively operated they have been at any time during the nearly four decades since I graduated from business school. What is holding them back is not the cost or the availability of credit and finance. What is holding them back is fiscal and regulatory policy that is, at best, uncertain, and at worst, counterproductive. Without fiscal policy that incentivizes rather than discourages U.S. capex (capital expenditure), this accommodative monetary policy aimed at reducing unemployment (especially structural unemployment) or improving the quality of jobs is rendered flaccid and less than optimally effective. And as to the housing markets, prices are now appreciating to levels that may be hampering affordability in many markets.

 

In my view, we at the Fed should begin tapering back our bond purchases at the earliest opportunity. To enable the markets to digest this change of course with minimal disruption, we should do so within the context of a clearly articulated, well-defined calendar for reducing purchases on a steady path to zero. We should make clear that, barring some serious economic crisis, we will stay the course of reduction rather than give an imprecise nod as we did after the May and June meetings that led markets to believe the program might end as unemployment reached 7 percent.

 

Plosser

Federal Reserve Bank of Dallas President Richard Fisher, who will be a voting member of the policy-setting committee next year, said he argued for a $20 billion reduction in the Feds monthly bond purchasing pace instead of the $10 billion announced last week. The market could have digested that, he said in an interview with Fox Business Network today.

I was pleased with the decision to finally begin tapering our bond purchases, though I would have preferred to pull back our purchases by double the announced amount. But the important thing for me is that the committee began the process of slowing down the ballooning of our balance sheet, which at year-end exceeded $4 trillion.

Here is a rather pungent quote from a note Peter Boockvar sent out on Jan. 2:

“…QE [quantitative easing] puts beer goggles on investors by creating a line of sight where everything looks good…”

For those of you unfamiliar with the term “beer goggles,” the Urban Dictionary defines it as “the effect that alcohol … has in rendering a person who one would ordinarily regard as unattractive as … alluring.”

Here is the point as to the market’s beer goggles. Were a stock market correction to ensue while I have the vote, I would not flinch from supporting continued reductions in the size of our asset purchases as long as the real economy is growing, cyclical unemployment is declining and demand-driven deflation remains a small tail risk; I would vote for continued reductions in our asset purchases, with an eye toward eliminating them entirely at the earliest practicable date.

Federal Reserve Bank of Dallas President Richard Fisher said Friday that the U.S. central bank's revamped interest-rate guidance might be "sloppier" than its previous incarnation but should be less vulnerable to any errors officials make in their forecasts.

In a speech at the London School of Economics, Mr. Fisher said the Fed has entered "unexplored territory" but that its new guidance is aimed at smoothing the transition between the Fed's expansionary period of large-scale asset purchases and the eventual return to higher interest rates.

"What we are trying to do now is to articulate the best we can what happens after our massive QE," Mr. Fisher said, referring to quantitative easing, another name for central-bank asset purchases.

"What we have done is we have de-quantified our guidance and are seeking to provide qualitative indicators of how we might proceed," he said.

The official added that "by its very nature qualitative guidance will be a little bit sloppy" and that investors tend to prefer more precision. But he said "you cannot expect specific quantitative guidance without mistakes being made," referring to forecasting errors that may have led investors to misjudge the central bank's intentions.
...
He said central banks pursuing forward guidance, which include the European Central Bank and the Bank of England, all are aiming "to ensure we have a sustainable recovery."

Mr. Fisher also sounded a warning note on risks that may be building in the financial system from a prolonged period of low interest rates, which many economists fret may inflate bubbles in asset prices.

"We are seeing in my opinion some exhibitions of excessive risk," he said, pointing to low yields on some riskier types of corporate bonds in particular.

Asked about the potential timing of eventual interest rate hikes, Mr. Fisher said it was too early to start the debate. He noted the central bank is gradually paring down its bond purchases, having reduced them to $45 billion per month at its April policy meeting. I personally expect us to end that program in October. Thats the first step, he said. Then we have to see how the economy is doing, including these broader measures of unemployment, and where we stand, before we can talk about how we might move the short-term rate. Ill make this prediction: Sometime in the next 100 years, interest rates will go up, Mr. Fisher quipped.

One has to bear in mind that monetary policy has to lead economic developments. Monetary policy is a bit like duck hunting. If you want to bag a mallard, you dont aim where the bird is at present, you aim ahead of its flight pattern. To me, the flight pattern of the economy is clearly toward increasing employment and inflation that will sooner than expected pierce through the tolerance level of 2 percent.

Some economists have argued that we should accept overshooting our 2 percent inflation target if it results in a lower unemployment rate. Or a more fulsome one as measured by participation in the employment pool or the duration of unemployment. They submit that we can always tighten policy ex post to bring down inflation once this has occurred.

I would remind them that Junes unemployment rate of 6.1 percent was not a result of a fall in the participation rate and that the median duration of unemployment has been declining. I would remind them, also, that monetary policy is unable to erase structural unemployment caused by skills mismatches or educational shortfalls. More critically, I would remind them of the asymmetry of the economic risks around full employment. The notion that we can always tighten if it turns out that the economy is stronger than we thought it would be or that weve overshot full employment is dangerous. Tightening monetary policy once we have pushed past sustainable capacity limits has almost always resulted in recession, the last thing we need in the aftermath of the crisis we have just suffered.

Many financial pundits protest that weaning the markets of ber-accommodation, however gradually, risks wreaking havoc, so dependent on central bank largess have the markets become. As a former market operator, I am well aware of this risk. As I have said repeatedly, a bourbon addict doesnt go from Wild Turkey to cold turkey overnight. But even if we stop adding to the potency of the financial punchbowl by finally ending our large-scale asset purchases in October, the punch is still 108 proof. It remains intoxicating stuff.

I believe the time to dilute the punch is close upon us. The FOMC could take two steps to accomplish this after ending our large-scale asset purchases.

First, in October, we could begin tapering our reinvestment of maturing securities and begin incrementally shrinking our portfolio. I do not think this would have significant impact on the economy. Some might worry that paring our reinvestment in MBS might hurt the housing market. But I believe the demand for housing is sufficiently robust to continue improving despite a small rise in mortgage rates. The economy is improving. An acceleration of income growth that will result will likely buttress a recovery in housing and compensate for the loss of momentum that occurred during the winter freeze. (As a sidebar, I note that according to the National Association of Realtors, overseas buyers and new immigrants accounted for $92 billion, or 7 percent, worth of home purchases in the U.S. in the 12 months ended in March, with one-fourth of those purchases coming from Chinese buyers. As Californians, you might find it of interest that Los Angeles was the top destination for real estate searches from China on realtor.com; San Francisco was second; Irvine was third.)

Importantly, I think that reducing our reinvestment of proceeds from maturing securities would be a good first step for the markets to more gently begin discounting the inevitable second step: that early next year, or potentially sooner depending on the pace of economic improvement, the FOMC may well begin to raise interest rates in gradual increments, finally beginning the process of policy normalization.

Many financial pundits protest that weaning the markets of ber-accommodation, however gradually, risks wreaking havoc, so dependent on central bank largess have the markets become. As a former market operator, I am well aware of this risk. As I have said repeatedly, a bourbon addict doesnt go from Wild Turkey to cold turkey overnight. But even if we stop adding to the potency of the financial punchbowl by finally ending our large-scale asset purchases in October, the punch is still 108 proof. It remains intoxicating stuff.

I believe the time to dilute the punch is close upon us. The FOMC could take two steps to accomplish this after ending our large-scale asset purchases.

First, in October, we could begin tapering our reinvestment of maturing securities and begin incrementally shrinking our portfolio. I do not think this would have significant impact on the economy. Some might worry that paring our reinvestment in MBS might hurt the housing market. But I believe the demand for housing is sufficiently robust to continue improving despite a small rise in mortgage rates. The economy is improving. An acceleration of income growth that will result will likely buttress a recovery in housing and compensate for the loss of momentum that occurred during the winter freeze. (As a sidebar, I note that according to the National Association of Realtors, overseas buyers and new immigrants accounted for $92 billion, or 7 percent, worth of home purchases in the U.S. in the 12 months ended in March, with one-fourth of those purchases coming from Chinese buyers. As Californians, you might find it of interest that Los Angeles was the top destination for real estate searches from China on realtor.com; San Francisco was second; Irvine was third.)

Importantly, I think that reducing our reinvestment of proceeds from maturing securities would be a good first step for the markets to more gently begin discounting the inevitable second step: that early next year, or potentially sooner depending on the pace of economic improvement, the FOMC may well begin to raise interest rates in gradual increments, finally beginning the process of policy normalization.

There are some who believe that macroprudential supervision will safeguard us from financial instability. I am more skeptical. Such supervision entails the vigilant monitoring of capital and liquidity ratios, tighter restrictions on bank practices and subjecting banks to stress tests. Although these macroprudential disciplines are important steps in reducing systemic risk, I also think it is important to remember that this is not your grandparents financial system. The Federal Reserve and the banking supervisory authorities used to oversee the majority of the credit system by regulating depository institutions; now, depository institutions account for no more than 20 percent of the credit markets. So, yes, we have appropriately tightened the screws on the depository institutions. But there is a legitimate question as to whether these safeguards represent no more than a financial Maginot Line, providing us with an artificial sense of confidence. [T]he term Maginot Line is commonly used to connote a strategy that clever people hoped would prove effective, but instead fails to do the job.

To get a sense of some of the effects of excess liquidity, you need look no further than Neil Irwins front-page, above-the-fold article in the July 8 issue of the New York Times, titled From Stocks to Farmland, Alls Booming, or Bubbling. Welcome to the Everything Bubble, it reads...

I spoke of this early in January, referencing various indicia of the effects on financial markets of the intoxicating brew we (at the Fed) have been pouring. In another speech, in March, I said that market distortions and acting on bad incentives are becoming more pervasive and noted that we must monitor these indicators very carefully so as to ensure that the ghost of irrational exuberance does not haunt us again. Then again in April, in a speech in Hong Kong, I listed the following as possible signs of exuberance getting wilder still:

-The price-to-earnings, or P/E, ratio for stocks was among the highest decile of reported values since 1881;
-The market capitalization of U.S. stocks as a fraction of our economic output was at its highest since the record set in 2000;
-Margin debt was setting historic highs;
-Junk-bond yields were nearing record lows, and the spread between them and investment-grade yields, which were also near record low nominal levels, were ultra-narrow;
-Covenant-lite lending was enjoying a dramatic renaissance;
-The price of collectibles, always a sign of too much money chasing too few good investments, was arching skyward.

I concluded then that the former funds manager in me sees these as yellow lights. The central banker in me is reminded of the mandate to safeguard financial stability.

Since then, the valuation of a broad swath of financial assets has become even richer, or perhaps more accurately stated, more careless. It is worrisome, for example, that covenant-lite lending has continued its meteoric revival and has even surpassed its 2007 highs.

[O]ne has to consider the root cause of the Everything Boom. I believe the root cause is the hyper-accommodative monetary policy of the Federal Reserve and other central banks.

At some point you cross the line from reviving markets to becoming the bellows fanning the flames of the Booming and Bubbling that Neil Irwin writes about. I believe we have crossed that line. I believe we need an adjustment to the stance of monetary policy.

I was uncomfortable with QE3, the program whereby we committed to a sustained purchase of $85 billion per month of longer-term U.S. Treasury bonds and mortgage-backed securities (MBS). I considered QE3 to be overkill at the time, as our balance sheet had already expanded from $900 billion to $2 trillion by the time we launched it, and financial markets had begun to lift off their bottom. I said so publicly and I argued accordingly in the inner temple of the Fed, the Federal Open Market Committee (FOMC), where we determine monetary policy for the nation. I lost that argument. My learned colleagues felt the need to buy protection from what they feared was a risk of deflation and a further downturn in the economy. I accepted as a consolation prize the agreement, finally reached last December, to taper in graduated steps our large-scale asset purchases of Treasuries and MBS from $85 billion a month to zero this coming October. I said so publicly at the very beginning of this year in my capacity as a voting member of the FOMC. As we have been proceeding along these lines, I have not felt the compulsion to say much, or cast a dissenting vote.

However, given the rapidly improving employment picture, developments on the inflationary front, and my own background as a banker and investment and hedge fund manager, I am finding myself increasingly at odds with some of my respected colleagues at the policy table of the Federal Reserve as well as with the thinking of many notable economists.

[W]ith low interest rates and abundant availability of credit in the nondepository market, the bond markets and other trading markets have spawned an abundance of speculative activity. There is no greater gift to a financial market operatoror anyone, for that matterthan free and abundant money. It reduces the cost of taking risk. But it also burns a hole in the proverbial pocket. It enhances the appeal of things that might not otherwise look so comely. I have likened the effect to that of strapping on what students here at USC and campuses elsewhere call beer goggles. This phenomenon occurs when alcohol renders alluring what might otherwise appear less clever or attractive. And this is, indeed, what has happened to stocks and bonds and other financial investments as a result of the free-flowing liquidity we at the Fed have poured down the throat of the economy.

Let me cut to the chase: I am increasingly concerned about the risks of our current monetary policy. In a nutshell, my concerns are as follows:

First, I believe we are experiencing financial excess that is of our own making. When money is dirt cheap and ubiquitous, it is in the nature of financial operators to reach for yield. There is a lot of talk about macroprudential supervision as a way to prevent financial excess from creating financial instability. My view is that it has significant utility but is not a sufficient preventative. Macroprudential supervision is something of a Maginot Line: It can be circumvented. Relying upon it to prevent financial instability provides an artificial sense of confidence.

Second, I believe we are at risk of doing what the Fed has too often done: overstaying our welcome by staying too loose too long. We did a good job in staving off the deflationary and depression risks that were present in the aftermath of the 200709 financial crisis. We now risk falling into the trap of fighting the last war rather than the present challenge. The economy is reaching our desired destination faster than we imagined.

Third, should we overstay our welcome, we risk not only doing damage to the economy but also being viewed as politically pliant.

Those of us who are the current trustees of the Fed's reputation- the FOMC- must be especially careful that nothing we do appears to be politically motivated. In nourishing the growth of the economy and employment, we must avoid erring on the side of coddling inflation to compensate for the inability of fiscal and regulatory policy makers in the legislative and executive branches to do their job. We must continue to protect the independence of the Fed.

I feel personally that we are closer to liftoff than we were, people felt we were, the market assumed we were, some time late in 2015... At the last meeting, I felt, as I listened to the discussion at the table, that my views were being digested by more and more participants.

Asman: So is Richard Fisher becoming a dove because he didn't dissent? Let's ask him.

Richard Fisher is Federal Reserve Bank of Dallas CEO and president -- you're not often called a dove, you have to admit that. But people were surprised that -- that you weren't the dissenting voice. And, in fact, here's what Mr. Plosser said about why he was a dissenter. He said, "The funds rate setting remains well behind what I consider to be appropriate given our goals."

Do you disagree with President Plosser on that?

FISHER: Well, first, David, just so you know, ornithologically speaking, doves are members of the pigeon family. I'm nobody's pigeon.

ASMAN: OK. There you go.

FISHER: I'm not, OK? So we've got to make that clear.

ASMAN: Now, there is also a charge, uh, and this one, I think, may be more on target, that the Fed is a little too concerned these days, for the past year or so, about how the markets will react to its policies. That is, there are people like Paul Volcker, who really squashed inflation by his actions back in the day. He didn't give a damn what the market felt about what needed to be done to maintain the integrity of the dollar.

Is it true that the Fed is paying too much attention to what the market is doing?

FISHER: I think there are some differences of opinion on that. I don't agree with that. I -- by the way, was trained by the same man that trained Paul Volcker. I'm very much a Volckerite. And I think what we should focus in on is the real economy.

I have argued publicly that 0 interest rates and this massive monetary accommodation, obviously, has distorted the markets. These valuations are very, very high, because the rates are so much lower because interest rates are so low. And eventually, they'll have to be an adjustment.

But, you know, the real thing is whether the real economy, putting people back to work, keeping inflation under control, propelling the economy forward toward greater prosperity, that's what I worry about.

And I am less worried about the money changers and whether or not we're going to disappoint some of them. As long as it doesn't lead to crippling the economy...

ASMAN: Well, as you mentioned, you were -- you were not only a hedge fund guy, a Federal Reserve officer, etc. You have a lot of touts. Most people didn't realize you were also a poet. Earlier, you talked about these dot charts that the Fed has come out with to describe what various Fed officials believe and now you think maybe it's time to get rid of them. And you put that dissent in the form of a poem, which I'm going to read.

"We gave you form so you'd inform about the price of dough, but all you've done is make for fun, and this we didn't know. So out, damned dot! Out with the lot! It's clearly time to go."

You know, I've got to tell you, it sounds a little like Dr. Seuss, Richard.

FISHER: I was channeling Dr. Seuss, David.

x

Dallas Federal Reserve President Richard Fisher told CNBC on Monday that recent stock market volatility has not changed his outlook for ending the central bank's bond-buying program "one iota."

"We have been floating this market with the Ritalin of easy monetary policy," said Fisher, a noted hawk. He's a voting member this year on the central bank's policymaking committee, which was poised to completely exit quantitative easing after next week's meeting.

The trimmed main which we calculated in Dallas which is a trim main on the PCE has been very steady at 1.6-1.7% for several months, so that tells me that there is no slide to the down side nor pressure on the upside. Whether were exactly at 2% in terms of the way I look at policy it doesnt make much difference the point is we have price stability and thats the important factor.

Together with the healthy rejuvenation of the balance sheets and equity prices of investment grade companies, we have seen what I consider to be a manifestation of an indiscriminate reach for yield, a revival of covenant-free lending, and an explosion of collateralized loan obligations (CLOs), pathologies that have proved harbingers of eventual financial turbulence.

Noticeably affected by QE3 have been the nominal yield levels of subpar credits and their spreads relative to investment-grade issues. Some 40 percent of newly issued CCC credits have negative cash flows.[2] And yet junk bonds have been trading at or near record historic low yields both in absolute terms and as measured by spreads over investment-grade credits. I worry about this as a risk that has been propagated by QE3, though I do not believe it is the Feds job to rescue reckless investors from the errors of their ways.

The stock market bottomed in March 2009 and had already more than doubled by the time we initiated QE3. It has since risen by another 40 percent; equities have, all-in, tripled in price since the lows of 2009. Only time will tell if stocks have risen to unsustainable heights and, if so, how deep a correction might be needed to bring them back to sustainable valuations.

I was pleased that we dropped the reference to significant in describing the remaining labor-market slack and that wording was included indicating we might well move to raise rates sooner than thus far assumed, should the economy proceed along the trajectory I think we are on. To me, this neutered the adjective considerable in stating the time frame under which we might act. This is why this particular hawk voted yes in support of the statement we released on Wednesday.

Especially at the beginning of QE3, when the nonsense term QE infinity was being broadcast by otherwise responsible analysts, journalists and pundits, rates dipped to lows that helped creditworthy businesses bolster their balance sheets and strengthen their wherewithal for future expansion. Again, even if you were living under a rock, you know that this gift of near-cost-free debt as measured in inflation- and tax-adjusted terms has thus far been used primarily to finance stock buybacks, increase dividends and fatten cash reserves, and recently, finance mergers by the most creditworthy companies. For those with access to capital, it was a gift of free money to speculate with. (One wagI believe it was mequipped that there was, indeed, a positive wealth effect the wealthy were affected most positively.)

Think about this: Heres a Congress that cant even get its own budget together. Do you want them running the central bank?

Take it to the extreme: We would end up playing to the cameras, which is what Congress does, and it would be a disaster, if Congress decided to audit Fed decisions, said Fisher, a former Democratic candidate for the Senate.

"I'll be blunt: we are audited out the wazoo," Dallas Fed President Richard Fisher said on Fox Business Network. "This (bill) is about interfering with the making of monetary policy. I respect the gentleman from Kentucky but he is wrong," Fisher said of Senator Rand Paul, who backs the bill.

Fisher repeated he expects the Fed to raise interest rates "some time this year."

ASMAN: How do you do it? Do you let the bonds expire? Do you actively sell them or what?

FISHER: Very slowly would be the answer. Now, again, I didn't want to go that far, but we did. It is a committee. It's a thoughtful group of people. That's what was decided.

But (INAUDIBLE) when we sell something we could sell.

ASMAN: OK.

FISHER: But I think that would be the last resort here because we have to be careful here. We've -- the markets have moved, according to us, you know the old saying, you don't fight the Fed. We have driven rates to historic lows.

I think we at the Fed must fully and frontally address the concern of many who feel that too much power is concentrated in the New York Fed. I am a great admirer of Bill Dudley. I consider him a dear friend and a man of tremendous capacity both as a policymaker and as a regulator of the financial institutions in his district. And I have enormous respect for Simon Potter and the good women and men who work our trading desk, faithfully implementing the instructions they receive from the FOMC, which crafts the nations monetary policy. Yet I understand the suspicions that surround the New York Fed.

There is an ancient Arab saying that one should "trust in Allah but tie your camel." I would suggest the following common-sense proposals for quelling concerns for securing our franchise as an independent Fed and, in fact, creating a more efficient policymaking and implementing process. Bill, you might not like these, but I think they are needed:

1) We should rotate the vice chairmanship of the FOMC. Under the current structure, the president of the New York Fed is the FOMCs permanent vice chair, which renders him the second-most-powerful person at the table, behind the Chair. The purpose of the FOMC is to decide policy and to instruct the New York trading desk to implement it by managing the Feds System Open Market Account and short-term trading operations. Having the New York Fed president as the FOMCs vice chair gives the appearance of a conflict of interest. To correct this, I would rotate that position every two years to one of the other 11 Fed presidents.

We have a convenient mechanism for doing so: The 12 Fed presidents meet frequently to discuss operational matters under the Conference of Presidents. Remember, there are no operating entities at the Board of Governors in Washington; it is the 12 Banks that lend money through their discount windows, house the forces that examine banks, operate the vaults that keep safe the peoples cash, and so on. The Conference of Presidents rotates its chair among the presidents on a biennial basis. So I would simply have the chairman of the Conference of Presidents automatically become vice chair of the FOMC. This way, over the course of two years, the Federal Reserve representatives of all 50 states (and all congressional districts) would occupy the second-most-important slot on the FOMC, and any appearance of conflicted interest would disappear.
...
I would give the Federal Reserve Bank presidents an equal number of votes as the Washington-based governors, save the Chair.

Presently, the New York Fed gets a permanent vote and the remaining 11 Banks get four votes, with Cleveland and Chicago voting every two years and the rest voting every three years. This makes no sense to me. The population of the New York Federal Reserve district is smaller than that of the San Francisco, Atlanta, Chicago, Richmond and Dallas districts. The Cleveland district is much smaller than New Yorks, roughly equal to that of Kansas City, and only slightly larger than that of St. Louis, Boston and Philadelphiaeach of which has 6 percent or less of the countrys population. (Minneapolis is the smallest district, with fewer than 3 percent of the nations population and roughly 1 percent of the Federal Reserves deposits.)
...
The current voting schedule makes no sense to me. But I wouldnt necessarily change it simply to avenge the past. I would change it to balance out the division of power between the Federal Reserve Banks that are out in the field and among the people and businesses that operate our economy and have their own independent research staffs, and the Board of Governors, which is Beltway bound geographically and is briefed and guided by a single staff. I have great admiration for the brilliance and integrity of the members of the Board of Governors research staff. But you will notice that for at least a couple of decades, the governors have tended to vote in a block, and it brings to mind Peter Weirs romantic comedy Green Card, where the character played by Gerard Depardieu chastises the woman played by Andie MacDowell, saying, "You get all your opinions from the same place." The members of the Board get their opinions from the same staff; the Fed bankers who sit at the FOMC table get theirs from 12 disparate staffs of the same high quality as that which resides in Washington.

I would give six Banks the vote to match the six governors other than the Chair. The next year, the other six would have the vote. The Chair would then be the tiebreaker if a tie were to ensue, though given the collegial way in which we conduct our deliberations, my guess is that a tiebreaker would be a rarity. Thus, over a two-year stretch, all 50 states and all congressional districts would have someone representing their constituents sitting as a voter at the table. Every year, six Fed Banks whose presidents serve under boards of directors chosen from within the states in their districts would match wits with Fed governors appointed by presidents and approved by Congress, providing a balance between what some might consider representatives of Main Street and Washington factotums. To me, this is eminently sensible.

My advice is to heed Charles Kindlebergers warning that "different circumstances call for different prescriptions." "The art of economics," he said, "is to choose the right model for the given problem, and to abandon it when the problem changes shape."

We have declared a 2 percent intermediate target for inflation, which seems to be standard for most central banks.

Right now, we are trying to understand the dynamics of inflation The headline personal consumption expenditures (PCE) price index fell 0.2 percent in December. Its 12-month increase was 0.75 percent, down from 1.6 percent in June. Should this low, and still falling, rate of price inflation retard the date of the liftoff from the zero-interest-rate policy we have been operating for more than six years?

I think not. We all know that headline inflation is being held down by the big decline in energy prices that began in the second half of 2014. We know that once energy prices stabilize, headline inflation is likely to bounce right back up. Policy needs to take past inflation into account, but it needs to take future inflation into account, too. Thats just another way of saying that, for policy purposes, its inflations medium-term trend that matterswhich is why analysts and policymakers pay so much attention to core inflation measures. The widely heralded FRB/US model that has been used by the Board of Governors staff since 1996 is an example: It is built around PCE inflation excluding food and energywhich is the traditional measure of core inflation. Ex-food-and-energy PCE inflation was essentially zero in December, month over month, while the 12-month rate slipped to 1.3 percent from 1.5 percent in June.
...
A good core inflation measure strips the noise out of headline inflation and leaves the signal. By that standard, recent analysis shows that the ex-food-and-energy PCE inflation rate that drives the FRB/US inflation forecast is a second-rate core inflation measure, at best. An alternative measure developed at the Dallas Fedthe Trimmed Mean PCEis superior in three respects.

First, trimmed mean inflation is better insulated from transitory energy-price swings. Since 1994 (the start of the current 2 percent-inflation era), conventional core inflations correlation with changes in the real price of oil is 0.26, while trimmed mean inflations correlation is just 0.05.

Second, as judged by root-mean-square error, it is more closely aligned with intuitive, direct measures of trend headline inflationlike the 36-month centered average, or headline inflations average over the coming 24-month periodthat we are only able to observe after the fact.

Third, trimmed mean inflation has shown substantially less systematic bias. Over the past 10 years, looking only at data that would have been available to policymakers in real time, conventional core PCE inflation has averaged 1.65 percentnearly 30 basis points below headline inflations 1.94 percent average. Meanwhile, trimmed mean inflation has come in at 1.83 percentjust 10 basis points below headline. Setting policy using conventional core as your guide is like navigating using a compass: It has a systematic bias and is influenced by local anomalies in the Earths magnetic field. Using the trimmed mean to set policy is more akin to navigating by GPS.

However, as I have repeatedly reminded my FOMC colleagues, every single time the Fed has waited for full employment to be achieved before starting to withdraw accommodation, it has ended up driving the economy into recession. When policymakers get too clever by half, the public pays a steep price.

I liken monetary policy to piloting a ship, as I learned to do at the Naval Academy. When you are at the connat the wheel of a large shipyou begin to slow down miles before you reach your intended destination. There are no brakes you can slam on to make a sudden stop. Ship velocity, like monetary policy, operates with a lag. If we wait to see the whites of the eyes of full employment and then have to raise rates sharply, I believe it will shock the economy and invite an adverse reaction. So, taking a page from Pope Francis, I hope we dont forget the past and will remember that the wisest policy option has proven to be early and gentle interest rate increases as we approach full employment.

I wanted {liftoff} to happen in March, and I lost the argument.

I would've liked to have seen us slowly raise rates. I was in favor of an early and slow approach.
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"To me, (a later date for the initial rate hike) means run the risk of doing what the Fed has always done. You get to full employment, you raise rates too rapidly and every time we've done that, we've driven the economy to a recession."
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Heres the point: I believe that rates will be raised in 2015. The question is the timing, and that will be decided by other people in the committee. I wanted to start in March, but I lost that argument.