UPDATE 1-Fed's Lacker: QE3 unlikely to boost jobs, could stir inflation

Mon Dec 17, 2012 3:37pm EST

* Fed is testing limits of credibility with latest policies-Lacker

* Unemployment threshold could tie Fed's hands on inflation, Lacker says

* Stein: Fed rules on foreign banks should make them more resilient

By Rick Rothacker

CHARLOTTE, Dec 17 (Reuters) - The U.S. Federal Reserve's latest policy actions are unlikely to do much to bring down unemployment and carry a "material" risk of sparking inflation, one of the U.S. central bank's most hawkish policymakers said on Monday.

"I see material upside risks to inflation in 2014 and beyond, given the current trajectory for monetary policy," Richmond Fed President Jeffrey Lacker told the Charlotte Chamber of Commerce Annual Economic Outlook Conference.

Lacker, who dissented at every Fed policy-setting meeting this year, also warned the central bank's growing stable of assets makes it much more vulnerable to "small errors."

The Fed is "straining to provide as much stimulus as possible without endangering our price-stability credibility," he said on CNBC television. "My worry and the reason I dissented ... is that we seem to be willing to test the limits of that credibility."

Last week the Fed said it would buy $45 billion in longer-term Treasuries each month, on top of its monthly purchases of $40 billion in mortgage-backed securities, until it sees a substantial improvement in the outlook for the U.S. labor market.

And for the first time, the Fed vowed to keep interest rates low until unemployment falls to at least 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent. This replaced a previous commitment to hold rates down until at least mid-2015.

Lacker said he backed dumping the calendar-based policy. But he argued the 6.5 percent threshold is "risky" because the unemployment rate is not a complete measure of the labor market, and because the Fed cannot directly control the jobless rate.

"The risk is that people become fixated on it, and it becomes an interference in our communications," he told CNBC, adding it could create tension with the Fed's mandate to keep prices stable.

It could also tie the Fed's hands, "preventing a preemptive move against inflation," Lacker told reporters later in the day.

"I should be clear I don't see inflation risks in the year ahead," he said. "And maybe they won't be large in 2014, but it's at that time where growth picks up where people are going to start questioning, 'Are they going to move pre-emptively or not?' that makes me worry about the implications of this."

Lacker added he expects the United States to reach 6.5 percent unemployment in about three years. The jobless rate was 7.7 percent last month, down from previous levels not because of fast job growth but because more discouraged workers are leaving the labor force.

Lacker forecast the U.S. economy to grow about 2 percent next year and to "begin to firm" the following year. A sudden rise in energy prices or an unexpected downturn in a major U.S. trading partner could knock that pace down, he said.

On the other hand, if U.S. lawmakers make convincing progress toward fiscal sustainability, a stronger-than-expected resurgence is "not inconceivable," he added, as relief releases a "rush of pent-up spending."

In any event, Lacker said, monetary policy alone can do little to improve economic growth or bring down unemployment, currently at 7.7 percent.

"Our primary responsibility at the Federal Reserve is to keep inflation low and stable," he said, noting that inflation has averaged near the Fed's 2 percent goal over the last 20 years.

"We do not really know whether monetary policy can make a sustainable difference in labor market outcomes, and we may be attempting to achieve more rapid improvement than is feasible," he said.

Federal Reserve Board Governor Jeremy Stein, speaking separately in Frankfurt, did not comment on the U.S. economic outlook or monetary policy in his prepared remarks, but instead focused on what he said would be the benefits of proposed rules from the Fed last week to tighten oversight of foreign banks.

The plan would force foreign banks to group all their subsidiaries under a holding company, subject to the same capital standards as U.S. holding companies. The biggest banks will also need to hold liquidity buffers.

"These rules should reduce the pressure on foreign banks that rely heavily on short-term dollar funding to either sell illiquid dollar assets or cut back on dollar lending in times of financial stress," Stein said.

A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

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