Fed policy views split due to uncertainty: Kohn

Federal Reserve Vice Chairman Donald Kohn (L) speaks with Bank of England Governor Mervyn King in Washington October 20, 2007.

NEW ORLEANS (Reuters) - Federal Reserve's vice chairman acknowledged on Saturday that the central bank's message had been clouded by a difference of opinions being voiced by policy-makers, but warned markets to learn to live with it.

"The resulting dispersion of messages has bothered market participants seeking clear, unambiguous guidance about the views of the central bank," Fed Vice Chairman Donald Kohn told the annual meeting of the American Economic Association in prepared remarks.

A copy of his speech was released to the media prior to delivery.

Critics complain the Fed has managed to sound both dovish and hawkish at the same time -- cutting interest rates while warning on the risks of inflation in policy statements.

This hints at a split between policy-makers that critics find worrisome, because it raises doubts about how far the Fed will be prepared to cut interest rates to shield the economy from a slumping housing market, increasing the odds of a recession.

Kohn made no apology. Instead, he argued a healthy debate was natural and would lead to better policy choices.

"The public should understand that the FOMC (Federal Open Market Committee) members do not coordinate schedules and messages, and that members' views are likely to be especially diverse when, as in the current situation, circumstances are changing quickly and are subject to many different analyses.

"The diversity of views on the committee is one of its strengths and vital to arriving at sound decisions," he said.

A full FOMC has 19 members, and this leaves investors with the problem of working out which ones to listen to most. Kohn simply noted Bernanke had recently taken the initiative to signal a change in outlook.

"We have attempted to let people know when our views of the macroeconomic situation had changed materially between FOMC meetings. ... Chairman Bernanke delivered a speech in late November after market conditions deteriorated again," he said.

Bernanke will speak again on the economy next Thursday.

FED FLEXIBILITY

The Fed has slashed interest rates a full percentage point to 4.25 percent since mid-September and investors see good odds it will cut by another half point at its next policy meeting after unemployment unexpectedly hit 5 percent last month. The next scheduled Fed meeting is for January 29-30.

Indeed, Kohn pointed toward the need for greater policy flexibility at times like these, in words that investors betting on more aggressive Fed rate cuts may find encouraging.

"When, as now, the FOMC believes that uncertainty is high, it may need to give greater weight to new information and be readier to revise its forecasts.

"Policy decisions may also take into account the substantial risk that the economy will turn out differently than the most likely forecast, especially when that alternative is seen as having unusually large costs," he said.

His remarks follow recent enhancements in the way the Fed communicates with markets. It has increased the number of annual forecasts to four and pushed out the time horizon of these projections to three years.

The initiative did not, however, endorse an explicit inflation target for the Fed.

Kohn had doubts about a target, which is something Bernanke has supported. But he said the Fed's solution had captured its main benefits and he held out the option of more change down the road.

"I expect our new projections will provide some of the benefits of an explicit target in better anchoring inflation expectations while not giving up any flexibility to react to developments that threaten high employment.

"As we gain experience with the enhanced forecasts, we will continue to evaluate how best to promote stability of both prices and employment," Kohn said.

(Reporting by Alister Bull, editing by Leslie Adler)