by Calculated Risk on 9/29/2010 01:31:00 PM

I cautioned that today was Fed speech day! Boston Fed president Eric Rosengren is currently a voting member of the FOMC ...

From Rosengren: How Should Monetary Policy Respond to a Slow Recovery?

I’ve called this talk “How Should Monetary Policy Respond to a Slow Recovery?” My answer to that question is: vigorously, creatively, thoughtfully, and persistently, as long as we have options at our disposal. And we do have options, despite having pushed short-term rates to the zero lower bound.

On unemployment:

[T]he most recent recession is far less a reflection of dislocation in a few industries but rather reflects a general decline in almost all industries. ... in this recession there has been a peak to trough loss of employment of 5 percent or greater in construction, manufacturing, retail trade, wholesale trade, transportation, information technology, financial activities, and professional and business services. To me, this does not suggest that the driver is structural change in the economy increasing job mismatches – although no doubt some of that exists – but instead I see here a widespread decline in demand across most industries.

And on QE2:

Now I’d like to make a few observations on Fed purchases of Treasury securities.

First, the positives: Purchases of long-term Treasury securities are likely to push down long-term interest rates on Treasury bonds, but also are likely to reduce rates on other long-term securities. Some have argued that it would be difficult to reduce Treasury rates further, but Figure 13 highlights, importantly, that U.S. Treasury rates are still well above the zero bound, roughly equivalent to rates in Germany, and well above long-term rates in Japan.

Now some concerns: While purchases of Treasury securities have the advantage of not directly “allocating credit” to a particular industry, they have the disadvantage of only indirectly affecting the private borrowing rates that more directly affect private investment spending. In addition, Treasury purchases raise for some a concern that the Fed intends to monetize the federal debt, using monetary policy to accommodate the financing of fiscal policy. I can assure you that we have no desire or intention whatsoever to do so.

While lower long-term rates are likely the primary channel through which asset purchases would influence the economy, purchases of Treasury or mortgage-backed securities also expand the Federal Reserve’s balance sheet and increase the amount of reserves in the financial system. This expansion of reserves might serve as an effective signal that highlights the determination of the Federal Reserve to reduce disinflationary pressures.

Certainly, views on securities purchases differ within the ranks of policymakers and all manner of observers. I would just reiterate that it is important to keep firmly in mind the goal of such purchases: to stimulate the economy by reducing long-term interest rates to a level that is more consistent with where they would be, were we able to further reduce the federal funds rate.

And his conclusion:

While the economy is growing, it is currently growing too slowly to significantly reduce the unemployment rate or stem disinflationary pressures created by the high degree of slack in the economy. While fiscal policies may be the most effective way to stimulate the economy when short-term interest rates approach the zero bound, unconventional monetary policies provide additional policy options. Of course, policymakers need to carefully weigh the benefits and costs of unconventional monetary policy – some of which I have tried to share with you today. Yet all in all, my firm view is that it is important that policymakers be open to implementing policies consistent with achieving full employment, and an appropriate level of inflation, within a reasonable time frame.

There is much more in this speech.