"With interest rates already extremely low and the Fed's balance sheet large and growing, monetary policy is posing risks to the economy in terms of financial stability, market functioning and price stability," Charles Plosser told attendees at the Economic Development Company of Lancaster County and EDC Finance Corp. annual meeting at the DoubleTree Resort by Hilton, formerly part of Willow Valley Resort.
The Fed's quantitative easing is a form of unconventional monetary policy. The Fed's normal channel of influence, the federal funds rate, is essentially zero, so it cannot be lowered further. Instead, the Fed is buying $85 billion a month in long-term bonds to inject cash into the economy and lower borrowing costs.
The FOMC, which sets Fed policy, has said the purchases will continue until unemployment drops substantially. Plosser, however, said this morning the benefits "are few and do not outweigh the potential costs."
The Fed's accommodation incentivizes businesses to take on excessive risk in a "search for yield," setting them up for losses down the road, he said. Firms holding long-term low-yield assets may suffer when interest rates rise, he added.
Lastly, the Fed's purchases have increased its balance sheet significantly, to the point where the banking system is holding $1.7 trillion in reserves at the Fed. The sheer scale of the Fed's balance sheet could make it tricky to tighten monetary policy once the FOMC chooses to do so, Plosser said.
Consumers are rationally and prudently trying to reduce debt, Plosser said. While they are doing so, spending will naturally remain sluggish; artificial stimulus may prolong the deleveraging period rather than shortening it, he said.
Plosser is considered one of the Fed's most consistent inflation hawks. His statements put him at odds with more dovish Fed members, including Chairman Ben Bernanke, who told the Senate Banking Committee in late February that quantitative easing is promoting "a stronger economic recovery and more rapid job creation."
In a short Q&A session, and in remarks to reporters after his speech, Plosser stressed his view that policymakers, including Congress, need to think about the long-term consequences of policy decisions. Too often, the focus is all on the short term, he said.
"When you have a crisis, the challenge is, 'Don't just stand there, do something,'" he said, "when in fact, in some cases the right answer is, 'Do nothing.'"
In his speech, he cautioned against expecting too much from Fed actions.
"Monetary policy is not a panacea for all our economic ills," he said.