SAN DIEGO Oct 3 The U.S. Federal Reserve will probably need to keep rates near zero for another two years to bring employment and inflation back to more normal levels, a top Fed official said on Thursday.
In remarks prepared for delivery to the University of California, San Diego Economic Roundtable, San Francisco Federal Reserve Bank President John Williams offered no new vision for how quickly the Fed should reduce its current $85-billion-a-month bond-purchase program.
But he reiterated his view that even after the U.S. central bank phases out its bond-buying program amid a strengthening economy, the Fed should keep monetary policy very accommodative for "quite some time."
By early 2015, he said, the U.S. unemployment rate will likely have fallen to 6.5 percent, the threshold at which the Fed has said it will consider raising rates again. Unemployment in August stood at 7.3 percent.
"I don't currently expect that it will be appropriate to raise the federal funds rate until well after that, sometime in the second half of 2015," he said.
The Fed shocked markets last month by keeping its bond-buying program intact, instead of reducing it as economists had expected. Stocks rose sharply, and bond yields fell as investors digested the reality that the Fed may keep policy easier for longer than they had expected.
The reaction underscored the difficulties the Fed will face as it moves to eventually take its foot off the monetary gas pedal.
"Swings in asset prices in response to Fed communications over the past several months demonstrate how hard it is to convey the (Fed's) policy plans in an evolving economic environment," Williams said. "The appropriate stance of monetary policy is very accommodative and that will continue to be the case for quite some time."
With unemployment well above the normal level of 5.5 percent and inflation running well below the Fed's 2-percent target, the Fed is still far from achieving its goals of maximum employment and price stability, he said.
"As the U.S. economy continues to improve, it will be appropriate for the Fed to start trimming its asset purchases and eventually stop them altogether," he said.
Once bond buys are phased out, Williams said, the Fed should go back to using short-term interest-rate targeting as its primary monetary policy tool, he said.
Asset buying has helped push down long-term rates, he said, with the current program of bond-buying likely to have reduced long-term Treasury yields by 40 to 50 basis points, he said. That's equivalent to a reduction in the short-term rate target of around 2 percentage points, he said, pointing to recent studies.
But the effects of asset purchases are also too uncertain for the Fed to continue using them once rates start returning to normal, he said.
"Certain types of unconventional policies are best mothballed and kept in reserve in case needed," he said.
The Fed should also return to more qualitative forms of guidance about future rate policy, he said. The U.S. central bank last year said it would keep rates near zero until unemployment falls to at least 6.5 percent as long as inflation stays under control.
Such a threshold policy, if used as part of the Fed's normal monetary policy, actually complicate communications challenges, he said.