Central Banks

Friday, April 7, 2017 - 14:53

NY Fed's Dudley Q&A: Stresses Any Pause Would Be'Little Pause'


By Vicki Schmelzer

NEW YORK (MNI) - If the U.S. economy "cooperates," the Federal Reserve will likely begin normalizing monetary policy either later this year, or early in 2018, said New York Fed President William Dudley Friday.

Nevertheless, while debating the topic, the Fed "has not made any formal decisions or announcements" yet, he said in Q&A as part of a luncheon in New York City, sponsored by the Griswold Center for Economic Policy Studies at Princeton University.

Dudley took the opportunity to clarify last week's remarks, i.e. that when the normalization process starts, the FOMC could take a "pause" in its interest rate hikes, as ending reinvestments could cause financial conditions to tighten.

"Some people misconstrued what I said last week. I said a little pause. A pause is pretty short already; I think a little pause is even shorter than that," he said.

"The idea is basically, when you make the decision you are going to normalize your balance sheet, that should have some consequence for long-term yields so that should tighten financial conditions," Dudley said.

Similarly, raising short-term interest rates also should translate into tighter financial conditions, he said.

So, when adjusting the balance sheet, "you might want to forgo the decision on short-term rates just to make sure that the balance sheet decision doesn't turn out to be a bigger decision than you thought it was going to be," Dudley said.

"So, I would emphasize the words 'little pause,'" he said.

Normalization will mean ending reinvestments and an eventual reduction in the Fed's balance sheet, he said.

"Once, we get to a point when we want to end the reinvestment process, we are probably going to do in a way that's gradual and phased out," he said.

"Once that process starts, the primary tool will be adjusting short term interest rates, not the balance sheet; We don't see the balance as an active tool for monetary policy," Dudley said.

The Fed's current $4.5 trillion in assets is a large footprint in the financial market, one that needs to be reduced as part of a return to normal monetary policy, he said.

Reducing the footprint now, means the Fed would have the ability increase its assets later in the event of emergency.

"You might want to have a Federal Reserve that actually has the capacity to potentially expand their balance sheet again in the future if we ever have another bad, bad recession," he said.

The Fed may not go back to the same diminished balance sheet size as before the financial crisis, because it could be constrictive, Dudley said.

When the normalization process starts, he favored going back to a system more like the current floor system, rather than the corridor system also being put forward. He noted that a floor system has the advantage of more safe assets.

On at times divergent trends of hard versus soft data, the Fed is still watching data closely.

"I just don't think we know yet," Dudley said.

--MNI New York Bureau; tel: +1 212-669-6438; email: vicki.schmelzer@marketnews.com

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