When the Fed finally drops its QE plan

New York, NY–(BUSINESS WIRE)–The Federal Reserve Bank of New York has issued a warning to investors that a planned policy to buy bonds by central banks, if implemented, could create an unwarranted risk of inflation.

“The central bank may be right to reduce its bond purchases when the economy is in contractionary territory,” wrote the New York Fed’s top policymaker, Jerome Powell, in a letter published in The Wall Street Journal on Thursday.

“But it may not be right for the economy to do so if the central bank has already committed to increase its purchases, or if there is a significant risk of a sudden surge in inflation.”

Powell went on to say that the central banks “should also consider how they can adjust their asset purchases when inflation rises.” 

The central banks QE program has been in place since 2008, when they decided to hold a bond buyback program until inflation was at least 1.5%.

But it has been controversial, particularly in the US, where some conservatives have argued that the Fed should not have bought any bonds at all. 

On Wednesday, the Fed held a special meeting in Washington to discuss the possibility of easing QE and inflation targeting.

Powell said that the bank has “long-standing discussions” with policymakers on ways to reduce the bond purchases. 

“We have long-standing conversations with policymakers and the president on ways that we can reduce the size of our asset purchases and we are in those discussions,” he said.

“We believe that monetary policy should not be the primary tool for reducing inflation.

And that it would be irresponsible to continue to pursue monetary policy that has unintended consequences.” 

In the letter, Powell also highlighted two key points: 1) If the Fed had been targeting inflation, it would have increased the size and duration of the bond buybacks in the second half of this year, when the Fed already increased the purchases in September. 

2) The Fed should have kept the program in place until the economy was already in contraction. 

In Powell’s view, if the Fed’s bond purchases were not in place by October, then the central bankers policy “could well have created the conditions for inflation to spike.” 

“In that case, the central banker’s actions would have created an unwary and self-interested market, one that would have driven up the price of the Treasury debt,” Powell wrote. 

The Fed has not commented on the letter. 

It comes after Powell, the US central bank’s chief economist, said in a speech on Wednesday that “the most important issue is to avoid a self-fulfilling prophecy” by the Fed to start buying bonds in order to boost the economy.

“What we’re trying to do is to keep the pace of growth slow, to keep inflation low, to avoid the risk of an unanticipated inflationary shock,” he told attendees at the University of Massachusetts.

“And to do that, we have to keep our focus on the economy and our long-term objectives.” 

Economists have been divided on whether the central government should take action to buy Treasury bonds, with many arguing that the money would be better spent on infrastructure and reducing unemployment, while others argue that the bond buys would encourage more debt in the economy, which could eventually lead to higher inflation. 

While the Fed has raised the price level of Treasury bonds by roughly 40 basis points this year (excluding dividends), the bond yields have not increased much, even as the economy has been contracting. 

Earlier this month, Powell said the central banking system was “in a unique position to determine when the appropriate time to start the bond-buying program is.”