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Richmond Federal Reserve Bank President Jeffrey Lacker said that he feels the Fed will be able to withdraw money stimulus to curb inflation when the economy begins to recover, but it must be cautious in deciding exactly when to withdraw that stimulus.
Speaking before the Danville Chamber of Commerce in Danville, Va., Lacker shrugged off concerns that the Fed will be willing and able to tighten monetary policy quickly enough to keep inflation in check.
"From a technical point of view, I do not see a problem - we do have the tools to contract our balance sheet and remove monetary stimulus when we need to do so, as Chairman Bernanke explained in detail in last month's Monetary Policy Report to Congress," he said.
However, Lacker went on to say that a harder problem would be deciding "when and how rapidly" to withdraw the stimulus when the recovery begins.
"I am certainly aware of the danger of aborting a weak, uneven recovery if we tighten too soon," he said. "But there can be a strong temptation to hesitate when emerging from a recession, awaiting conclusive signs of robust growth. Keeping inflation well-contained may require action before a vigorous recovery has had time to establish itself."
Lacker went on to discuss the Federal Open Market Committee announcement that it would slow its purchases of Treasury securities and stop them by the end of October, and what it would mean for further Fed policy decisions.
"Purchases of agency debt and agency mortgage-backed securities continue, however, and those purchases supply reserves which reduce the amount that banks need to borrow from the Fed to satisfy their elevated demand for reserve account balances," he said.
He added that if those purchases continue, banks will no longer need to borrow to maintain their desired level of reserve balances, making further asset purchases push the supply of reserve balances beyond demand and necessitate downward adjustments in other yields.
Lacker went on to conclude that this could induce banks to voluntarily hold large balances and provide more monetary stimulus that past asset purchases have provided, and he promised to evaluate whether such an additional stimulus is needed.
"With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus that purchasing the full amount authorized under our agency mortgage-backed securities purchase program would provide," he said.
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