FOMC's Lacker denounces committee's new normalisation principles

A long-term member of the Federal Open Market Committee (FOMC) today criticised the Fed's policy ‘normalisation' plan for jeopardising half-a-century's worth of established practice and blurring the lines between fiscal and monetary policy.

The FOMC published principles setting out how it intends to normalise US monetary conditions following years of ultra-loose policies on Wednesday, revealing it does not expect to sell mortgage-backed securities (MBS) as part of the process.

Today, Jeffery Lacker, the president of the Federal Reserve Bank of Richmond, said he "cannot support the committee's planned approach" to balance sheet reduction.

According to Lacker, an FOMC member since 2004, a failure to shed MBS from the FOMC's $4.4 trillion balance sheet "unnecessarily prolongs interference" in credit allocation. Instead he prefers to "actively reduce" MBS holdings through "steady, predictable" sales.

"The Fed's MBS holdings may put downward pressure on mortgage rates, compared to holding an equivalent amount of Treasury securities, but if so, then other borrowers would likely face higher interest rates," Lacker argued. "While this would favour home mortgage borrowers, it tilts the playing field against other borrowing by consumers.

"The desire to avoid such effects is a long-standing principle in the conduct of US monetary policy over the last half-century", and is articulated in the committee's guidelines for conducting open market operations, he added.

Lacker, who noted the Fed and the US Treasury "reaffirmed" this principle in March 2009, argued that "tilting the flow of credit toward some sectors and away from others" was an inappropriate use of the Fed's balance sheet.

"It involves distributional choices that should be made through the democratic process and carried out by fiscal authorities, not by an independent central bank," he said.

Charles Calomiris, Henry Kaufman Professor of financial institutions at Columbia University, said: "Buying these securities was itself an inappropriate and unnecessary fiscal action by the Fed. Keeping them just compounds the error. I am glad that president Lacker is demonstrating courage and speaking this obvious truth".

Lacker said he did support the other elements of Wednesday's statement on policy normalisation.