Fed seen pressing on with stimulus, mindful of risks
(Reuters) - The Federal Reserve looks set to continue its bond-buying stimulus for the foreseeable future despite hints of strength in the economy and rising concern about the policy's risks, comments from top officials indicated on Thursday.
Charles Evans, president of the Chicago Federal Reserve Bank who is a known as a policy dove, said the central bank may need to keep up its purchases of bonds through the end of this year or into the next, and may even need to add to the program if fiscal restraint is greater than expected.
"I think we have pretty appropriate policies in place right now," Evans said in an interview with CNBC. He said he expects U.S. economic growth of about 2.5 percent this year, even accounting for the effect from a tighter government budget.
"If we have more of a drag this year that's more of a headwind, that might mean we have to do a little bit more," he said.
The U.S. central bank last month left in place its monthly $85 billion bond-buying stimulus plan, reiterating its pledge to keep up purchases until there is substantial improvement in the labor market outlook.
Still, in a sign of growing internal worries about the risks of the Fed's low-rates stance, Fed Board Governor Jeremy Stein gave a speech focusing chiefly on the potential threats from highly expansionary monetary policies.
He argued that an extended period of low interest rates could create risks to financial stability, and policymakers should keep an eye on junk bond and leveraged loan markets for signs of excess risk-taking.
As for whether a bubble is already forming, Stein said the current evidence is inconclusive.
"In terms of the variables that could be informative about the extent of market overheating, the picture is mixed," Stein said at a conference sponsored by the St. Louis Federal Reserve Bank.
Stein's remarks come at a time when some analysts, including top Fed officials, have raised concerns about the potentially destabilizing effects of the central bank's unconventional monetary policies, in particular the asset-purchase program.
In December the Fed reinforced its third round of quantitative easing, replacing a more modest earlier program that did not add to its balance sheet with a more aggressive buying of Treasuries, maintaining the monthly pace of $85 billion in purchases first established in September.
With U.S. stocks rallying sharply in January and corporate bond issuance breaking records, some worry the Fed's low rates policy might encourage investors to take on excess risk. Stein argued policymakers should remain attuned to these risks and not shy away from using monetary policy to mitigate them - a break with past convention, which has tended to favor regulatory tools to deal with asset price inflation.
"If the underlying economic environment creates a strong incentive for financial institutions to, say, take on more credit risk in a reach for yield, it is unlikely that regulatory tools can completely contain this behavior," Stein said.
"Waiting for decisive proof of market overheating may amount to an implicit policy of inaction on this dimension."
Evans remained convinced, however, that the benefits of the third round of quantitative easing, or QE3, still far outweigh the potential costs.
CARBING UP FOR RECOVERY
Evans, a voting member this year on the Fed's policy-setting panel, repeated his view that he would need to see a gain of 200,000 jobs a month for about six months in order to dial back the program.
He also said he would want to see above-trend growth in gross domestic product and a decline in the unemployment rate, now at 7.9 percent.
Evans said while he does not expect unemployment to fall to around 7 percent until late 2014, the Fed could ease up on its purchases before then.
He compared the Fed's asset-buying program to loading a runner with carbohydrates before a half-marathon. "I tend to think it might be possible to turn off the quantitative easing.
"We get off to a fast start on the run, we build momentum, and then we're just going to keep going, it's self-sustaining -- we wouldn't have to continue to carb up along the run, and so that's why we might be able to stop before 7 percent," Evans said, adding, "But I'm open-minded."
In December, the Fed announced a new framework in which it plans to use economic indicators to give the market a clearer picture of the policy outlook. In particular, it has vowed to keep interest rates near zero until the jobless rate falls to at least 6.5 percent as long as medium-term inflation is not forecast to exceed 2.5 percent.
Evans pointed to auto sales and improving housing market as evidence the asset-purchase program is working to boost the economy, which he expects will eventually bring down unemployment.
"Once we get momentum and achieve escape velocity, either later this year or 2014, I think unemployment will move down with momentum," he said.
(Reporting by Pedro da Costa in Washington, D.C., and Ann Saphir in Chicago; Editing by Leslie Adler)