Fed should switch other assets for Treasuries: Plosser

The move would also help draw a clearer distinction between monetary and fiscal policy to ensure the Fed's independence does not come under attack, Philadelphia Federal Reserve Bank President Charles Plosser said in remarks prepared for delivery to a forum on monetary policy.

"The current crisis and the Fed's interventions have dramatically altered the composition of the assets on our balance sheet and created confusion in the minds of many as to the respective roles of the central bank and the fiscal authority," Plosser said.

The U.S. central bank's balance sheet has more than doubled to around $2 trillion as it pumped hundreds of billions of dollars into key credit markets. It has bought assets that it would not usually hold on its balance sheet, including agency debt and agency mortgage-backed securities.

An agreement with the Treasury to switch U.S. government bonds for these less-liquid non-traditional assets on the Fed's balance sheet would help the central bank focus on conducting traditional monetary policy.

"With Treasuries back on the balance sheet, the Fed will be able to drain reserves in a timely fashion with minimal concerns about disrupting particular credit allocations or the pressures from special interests," said Plosser, who is not a voting member on the Fed's policy-setting committee this year.

He said such an agreement would transfer funding of the credit programs to the Treasury, "thus ensuring that credit policies that place taxpayer funds at risks are under oversight of the fiscal authority.

"Second, it would return control of the Fed's balance sheet to the Fed, so that we can continue to conduct independent monetary policy," he said.

Plosser said it is important for the Fed to articulate a clear exit strategy from its credit policies and anticipate that political pressures could make it more difficult to shrink its balance sheet quickly enough when the time comes.

Longer-term assets, such as agency MBS, "may prove difficult to sell for an extended period of time if markets are viewed as 'fragile' or specific interest groups are strongly opposed," he said, adding that this could lead to inflation down the road.

"We must ensure that our current credit policies do not constrain our ability to conduct appropriate monetary policy in the future," Plosser said. He said the "jury is still out" as to how effective these so-called credit easing policies will be.

Plosser reiterated his call for an explicit inflation target and said the Fed should publicly commit to achieving that target over an intermediate time horizon.

"Such a commitment would help anchor expectations more firmly and diminish concerns of persistent inflation or persistent deflation -- not an inconsequential issue in the current environment," he said.

It could also be useful, Plosser said, for the policy-setting Federal Open Market Committee to publish quarterly projections of members' assumed policy paths.

He said the Fed also needs to clarify the criteria under which it steps in as a lender of last resort.

"We must spell out when we will intervene in markets or extend unusual credit to firms -- and then we must be willing to stick to those criteria," he said.

Plosser said the lack of clear ground rules can lead to markets speculating on what the next asset class or company the Fed will rescue. This is counterproductive and can lead to increased market volatility, he warned.

(Reporting by Kristina Cooke; Editing by Dan Grebler)