Fed independence doubts could hurt recovery: report

NEW YORK Sun Nov 22, 2009 6:17pm EST

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NEW YORK (Reuters) - The independence of the Federal Reserve is essential for credible monetary policy and doubts about the U.S. central bank's ability to do its job without political interference could hurt the nascent economic recovery, a senior Federal Reserve official said on Sunday.

"Talk of eroding the Fed's independence can be counterproductive for economic recovery," St. Louis Federal Reserve Bank President James Bullard said in slides to accompany a presentation prepared for a panel discussion in New York.

Bullard said that non-independent central banks have historically been forced to finance large government budget deficits. "This can be very inflationary," he added.

Last week, a U.S. congressional panel approved a measure to open the Fed's monetary policy decisions to government audits -- a surprise blow to the central bank's efforts to shield its independence and a signal of the frustration on Capitol Hill with the central bank.

The amendment was a further congressional slap at the U.S. central bank after a Senate regulatory overhaul proposed stripping the central bank of its regulatory authority.

Some lawmakers fault the Fed for failing to anticipate or prevent the financial crisis that pitched the economy into a deep recession.

Bullard batted back criticism that the Fed missed the brewing crisis, saying the central bank provided "important warnings" before the crisis began.

He noted that his predecessor at the St. Louis Fed, William Poole, argued in the early 2000s that Fannie Mae and Freddie Mac were "ticking time bombs," while former Federal Reserve Bank of Minneapolis President Gary Stern published a book entitled "Too Big To Fail," warning some financial firms were growing too large for proper supervision.

"These types of warnings show that the Fed is well aware of systemic risk concerns in real time," Bullard said in his slides.

He argued the Fed needs a role in regulating institutions to whom it may lend if required to as the "lender of last resort."

Bullard also said that to do its job of setting monetary policy effectively, the Fed needs to know the conditions of the financial system.

"The need to know the status of financial markets has been underscored by recent events," Bullard said. The United Kingdom's model, in which the Financial Services Authority is in charge of regulation and the Bank of England is in charge of monetary policy "did not work well during this crisis," he said.

"The crisis in the UK has been even worse in some dimensions than in the U.S.," Bullard said.

He also said that despite the current crisis, the Fed's track record of handling crises in the last 25 years has been "reasonably good."

Bullard, who will vote on the Fed's policy-setting panel next year, did not comment on outlook for monetary policy.

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