FedÕ Pianalto: Tapering QE could ease looming risks

The various risks posed by the central bank’s ultra-easy monetary policies could be reduced by simply slowing the pace of asset purchases, said Sandra Pianalto, president and CEO of the Federal Reserve Bank of Cleveland.

Nonetheless, the Cleveland Fed president noted the Federal Open Market Committee’s current policies have worked to boost economic growth and stabilize the job market.

However, the potential future risks to the economy such as a historically large balance sheet, which could curtail the recovery, are encouraging Pianalto to pump the breaks on the open-ended third round of quantitative easing program.

Currently, the FOMC remains committed to purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion a month.

“If the outlook for labor market conditions were to improve sufficiently, the FOMC could begin to slow the pace of asset purchases and limit the size of the overall program. But other considerations could lead to the same result,” she explained.

The Federal Reserve’s balance sheet could swell to $4 trillion by year-end, which could present its own uncertainties and risks to the market. 

“The Federal Reserve has never before had a balance sheet anywhere close to the size we have today, nor has the Federal Reserve ever before taken such large positions in the Treasury and mortgage-backed securities markets,” the Cleveland Fed president said.

One way to mitigate potential risks is through a smaller-sized balance sheet than many market experts currently envision.

“Given our limited experience with our asset purchase programs, slowing the pace of purchases could help minimize the potential risks associated with our large and growing balance sheet,” Pianalto explained.

Thus, limiting the size of the overall program would enable the central bank to continue adding accommodation and providing support to economic growth and job creation. 

Meanwhile, Pianalto amplified her belief that monetary policy cannot offset large-scale fiscal restraint. 

“The treat of fiscal austerity in the U.S. and in other countries around the world represents a near-term risk to the global economic recovery. Large debt obligations in many countries present risks to long-term economic growth,” she said.

Thus, America’s economic performance will depend considerably on fiscal policy.

The challenge is for policymakers to enact a plan to put the federal budget on a sustainable long-term path without reserving the recovery.

“Monetary policy is supporting economic growth, but monetary policy has limits. In current circumstances, it would be particular helpful if fiscal and regulatory polices were among the forces supporting economic growth,” Pianalto said.

She concluded, “I believe that our accommodative monetary policy stance is keeping the U.S. economy on the path of economic recovery, and is contributing to both U.S. and worldwide economic growth. But we are in uncharted waters. So, it is important that we continue to evaluate the risks associated with our policy actions.” 

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