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A hawkish Philadelphia Fed: Charles Plosser’s important speech

Kshitija Bhandaru

Economic overview

Philadelphia Fed President Charles I. Plosser delivered a speech on “Monetary Policy and Banks and the Rise of Global Protectionism” in Paris on March 10, 2014. The avowed policy hawk, who’s a voting member of the Federal Open Market Committee (FOMC) this year, is a long-time critic of the Fed’s bond-buying program, which is meant to spur economic growth.

Pointing to the improvements in hiring we’ve seen throughout 2013, and given his expectation for less “fiscal drag” over the course of 2014, Plosser believes the economy is on a sounder footing and will grow by 3%, and inflation will move up to 2% over the year.

Communication problems

Plosser, however, warns of looming communication problems if the Fed keeps buying assets while the unemployment rate declines. He argues that as the labor markets improve while the Fed continues with its bond buying program, the currently low inflation might increase rapidly.

The FOMC in December 2013 announced that it would reduce the pace of asset purchases by $10 billion every month—also known as “tapering”—and end its asset purchase program later this year. Plosser mentioned that while tapering is the right move, the pace of the taper should increase.

Forward guidance

Plus, Plosser added that the forward guidance ought to clarify what the Fed is trying to achieve through its policy framework. “The FOMC has not been clear about the purpose of its Forward Guidance,” he stated, stressing that effective forward guidance requires commitment, but discretion undermines the effectiveness of forward guidance, and the whole purpose is lost.

Plosser concluded by saying that since the onset of the financial crisis, the Fed shifted to a more “interventionist” approach. He commented, “If financial market participants believe that their success depends on the decisions of monetary policymakers, our capital markets will cease to deliver the economic benefits they are capable of providing.” This interventionist approach, he said, could negatively affect economic agents’ decisions.

Fed tapering is a great interest for bond ETFs like the iShares 20+ Year Treasury Bond ETF (TLT), the Vanguard Total Bond Market ETF (BND), and the iShares Core Total U.S. Bond Market ETF (AGG) as well as MLPs such as Crosstex (XTEX) and Kinder Morgan Energy (KMP), and MLP ETFs such as the Alerian MLP ETF (AMLP).

To learn more about the Fed’s outlook, see the Market Realist series Charles Evans sheds light on the Fed’s long-run monetary policy.

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