Plosser, Dissenting Fed Voter, Says Price Stability Is Priority

By John Brinsley
March 28 (Bloomberg) — Federal Reserve Bank of Philadelphia President Charles Plosser, who voted against this month’s interest-rate cut, said keeping inflation in check is the “most effective” way of ensuring economic growth and job creation.

“Price stability is not only a worthwhile objective in its own right,” Plosser said in the text of a speech at a conference in Cape Town today. “It is also the most effective way monetary policy can contribute to economic conditions that foster the Federal Reserve’s other two objectives: maximum employment and moderate long-term interest rates.”

Plosser said today that keeping prices steady has to be the primary obligation of the central bank in order to ensure the economy runs as efficiently as possible. Price stability helps an economy’s ability “to achieve its maximum potential growth rate,” he said.

This is the mainstream macro economic position. (Not mine!)

It also addresses the dual mandate in the only logical manner the mainstream theory can address:

Low and stable inflation is the necessary condition for optimal growth and employment.

And they have volumes of maths to back it up.

In an effort to fend off a U.S. recession, Fed Chairman Ben S. Bernanke and his colleagues have slashed the federal funds rate by 2 percentage points this year, the most aggressive easing in two decades, even as surging oil and food costs threaten to stoke inflation. Plosser and Dallas Fed President Richard Fisher opposed the March 18 decision to cut the Fed’s main lending rate by three-quarters of a percentage point to 2.25 percent.

“Stable prices also make it easier for households and businesses to make long-term plans and long-term commitments, since they will know what the long-term value of their money will be,” Plosser said. “Price stability helps a market economy allocate resources efficiently and operate at its peak level of productivity.”

The Fed has lowered its benchmark rate six times in as many months since the collapse of U.S. subprime mortgages started to infect markets around the world in August last year. The world’s biggest financial companies have posted at least $195 billion in writedowns and credit losses tied to American mortgage markets.

“There seems to be a view that monetary policy is the solution to most, if not all, economic ills,” Plosser said. “Not only is this not true, it is a dangerous misconception and runs the risk of setting up expectations that monetary policy can achieve objectives it cannot attain.”

Public misconceptions over what central banks can and cannot do have “risen considerably over the years.” Central banks must therefore effectively communicate their goals and limitations, Plosser said.

The mainstream position is that rather than add to demand to address near term weakness and risk elevating inflation expectations, the government should instead let the output gap (unemployment and excess capacity in general) rise and bring inflation down.

If it does add to demand in an attempt to keep the output gap low and inflation elevates, a much larger output gap will soon be required to reign in the accelerating inflation problem.

The dissenting votes reflect this mainstream view that appears to be playing out in the least desirable way.

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