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Dissent Between Fed Presidents: Maybe That's A Good Thing

The presidents of the New York and Richmond Federal Reserve Banks are taking different sides on whether to make an early withdrawal on measures to pump up the U.S. economy. It's more a matter of degree rather than a real smackdown. But maybe this is a good sign about the economy, that there are enough signs to persuade a really smart guy that an upturn is here.

The two Fed presidents weren't in a debate, or even at the same lectern. This morning, August 31, New York Fed president William Dudley told the CNBC audience that despite early indications of a recovery, it's too soon to consider cutting back on the Fed's purchases of long-term bonds.

The bond purchases are one of the unorthodox measures the Fed took after the financial crisis. The objective in buying bonds -- $300 billion worth of Treasuries, $200 billion of agency bonds, and $1.25 trillion of agency mortgage-backed securities - is to keep prices high, and in turn keep interest rates low, so lower financing costs can work their simulative magic on housing and other credit-sensitive sectors. (The tactic goes by the name "quantitative easing.")

Dudley cautioned, according to Reuters, that the bond market's frame of mind is just as important as what's happening in the real economy:

Market expectations are very, very important, and the market expects us to complete these programs, to do the full amount... To contradict that market expectation, I think, is a pretty high hurdle.
In other words, the bond market may think the economy is still too fragile, and the last thing we want to do is upset the bond market. (I wrote about those pessimistic market views last week.)

In the other corner of the bond-buying debate is Richmond Fed president Jeffrey Lacker, who spoke last week to the Chamber of Commerce in Danville, Virginia. (Danville was the last capital of the Confederate States of America, and the setting for the songs "The Night They Drove Old Dixie Down" and "The Wreck of the Old 97.")

Lacker spoke on the economy, of course:

I've identified three areas on the demand side of the economy where we have some grounds for cautious optimism, namely housing, autos and exports. We also have seen some promising news on the supply side - namely, in the cyclically sensitive manufacturing sector.
Today, August 31, Lacker's side was bolstered by a reading from the Institute of Supply Management - Chicago, saying that its manufacturing index had risen to a level of 50. Index readings above 50 denote an expansion in factory activity, and the Chicago index tends to move closely with the nationwide index, notes economist Asha Bangalore of Northern Trust.

President Lacker closed his remarks with his thoughts on bond purchases:

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.
That's hardly drawing a line in the sand and daring President Dudley to cross. But Lacker is an accomplished economist and academic who knows how to read the tea leaves, and it's encouraging that he thinks the economy is that far along in a recovery.

It's also good to hear that senior people at the Fed are actively concerned, today, about taking the stimulus too far.

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