UPDATE 2-Fed's Bullard: Don't rely on rates to fight crisis

Tue Oct 14, 2008 11:03pm EDT

(Updates with Bullard remarks to reporters)

By Alister Bull

MEMPHIS Oct 14 (Reuters) - The U.S. economy risks a protracted slump if government action fails to counter the credit crisis, but the Federal Reserve should not cut interest rates any further, a top Fed official said on Tuesday.

"Overreliance on interest rate policy in this environment does little to solve the problems at hand and, in addition, may cause a new and difficult-to-solve inflation problem in the wake of the current turbulence," St Louis Federal Reserve President James Bullard said in a speech.

Bullard is not a voting member of the Fed's interest-rate setting committee this year, and has been outspoken in recent weeks about the risk that cutting rates too low could stoke inflation in the future.

He later told reporters, in more hawkishly pointed remarks, that he did not favor additional Fed policy easing.

"We had a pre-emptive policy where we dramatically lowered rates earlier in the year... At the levels we're at now, I don't think that further moves would do much good, he said.

The Fed, acting in coordination with other central banks in Europe and Asia, cut interest rates by a half point last Wednesday to 1.5 percent and warned that the global credit crisis would seriously impact the economy.

The move was taken amid collapsing world wide stock markets as investors lost faith in financial institutions and took fright. Investors think they will act again.

Financial futures imply an almost 90 percent likelihood the Fed will cut rates by 25 basis points at its next meeting, on Oct. 28-29, in the face of a serious slowdown.

But Bullard cautioned that this was not the right policy prescription for what ailed the U.S. economy.

"Moving interest rates in an environment as uncertain as this one does not have a big effect and can get lost," he told reporters.

"Interest rates are a very broad and blunt policy instrument and, above all, (do) not really specifically address (the) problems we're facing."

On the other hand, he acknowledged that there were grave risks confronting the country.

"It is far from clear how financial market turmoil of this magnitude will ultimately affect the real economy. Unchecked, the turmoil could have severe negative consequences," he told The Economic Club of Memphis.

"The economy may have slowed significantly in the third quarter. This slowing is associated not so much with financial market turmoil, but instead with the rapid run-up in energy and commodities prices during the spring and summer, along with increasing weakness in labor markets," he said.

Crude oil peaked at about $147 a barrel in July, but has since fallen by about 45 percent to around $79 on growing concern that the economy could slip into recession and drag down demand. Other commodities prices have fallen in a similar fashion.

Bullard said that aggressive action by the Fed and the government -- which has pulled together a $700 billion bank bailout package -- could ensure that the country escapes the fate of Japan's "lost decade" of stagnation in the 1990s.

"If financial market turmoil can be contained, possibly through aggressive government policy, then a relatively benign outcome is possible in which U.S. economic performance is sluggish but does not involve a protracted downturn," he said. (Editing by Leslie Adler)

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