Kansas City Fed President Thomas Hoenig continues to believe rates need to rise, which leaves him in opposition to the decision made just over a week ago to maintain the size of the Fed's balance sheet. St. Louis Fed President James Bullard, meanwhile, has talked of going even further than what's been done thus far, suggesting the Fed could again expand its balance sheet if the recovery falters further. Minneapolis Fed leader Narayana Kocherlakota thinks it's all a tempest in a tea cup, describing the Fed actions as technical and misunderstood by markets as a sign of growing worry over the outlook.
As the article later points out, Hoenig's position is of limited relevance as he is, and has remained, the lone voice calling for a rate increase. The real action is between Bullard's and Kocherlakota's positions. About them, the RTE blog continues...
Bullard, however, framed the issue in a way that lined up neatly with the prevailing market view. He told The Wall Street Journal in an interview "I thought we should be in a position to return to a quantitative easing program if we got further disinflation."
Kocherlakota muddied the waters Tuesday, saying the market got the issue wrong. Low rates are driving more mortgage prepayments than the Fed anticipated, so purely for technical reasons, the Fed needs to act to keep its portfolio size up. "I would say that there is no new information about the current state of the economy to be learned from the FOMC's actions or its statement," the policymaker said.
Kocherlakota is refreshingly direct about it. To say that there is "no new information" certainly puts the markets in their place. That sort of candor, along with a plausible technical reason, is helpful to outside observers, even if it seems to "muddy the waters." Kocherlakota's view is consistent with the notion that the Fed needs to make sure that they don't accidentally contract. Certainly, that is a sensible position. The question is whether it goes far enough.
Bullard wants to make sure the Fed can go further if they need to. Will they? That remains to be seen. And in the remainder of 2010, that will be the big question.
It remains somewhat unclear to me what the Fed can do to improve the labor market, which is the primary concern now. Fiscal policy, in a perfect world, would be better suited for that although fiscal policy is being held hostage to politics, and probably will be for a while. So everyone will be looking to the Fed to do something. Aside from making sure they don't passively and unintentionally contract the credit supply, it's not clear how they can achieve the effects that people want.
Ultimately, you can't quite square the two positions. The best I can do is to say that I agree with Kocherlakota today, but Bullard might be right tomorrow. Pulling the trigger too early could be destabilizing and may not necessarily have the positive effects you want. Policy lags notwithstanding, I wouldn't be ready to take the risk yet.
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