WRAPUP 1-Fed official: New chair to face key test on keeping policy easy

Fri Oct 4, 2013 6:05pm EDT

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Oct 4 (Reuters) - The key challenge for the next chair of the Federal Reserve will be resisting pressure for a premature tightening in monetary policy, a senior U.S. central banker said on Friday.

Narayana Kocherlakota, president of the Minneapolis Federal Reserve and one of several policy doves arguing the case for more action to spur U.S. hiring, said most observers think the main problem for the Fed will be ending ultra-easy money. He said it is not.

"The real test for us ... (is) going to be about being able to keep a high level of accommodation in place, even as there (are) a lot of onlookers and observers calling on us to back off," he said. "The leadership being provided by the chairperson in that regard will be critical."

President Barack Obama is expected to nominate his choice to succeed Fed chief Ben Bernanke, whose term ends in January, in the next few weeks. A White House source has said that Fed Vice Chair Janet Yellen is the top candidate.

Some observers argue that whoever succeeds Bernanke will be judged on how smoothly an exit from five years of unprecedented monetary easing is executed.

The Fed cut interest rates almost to zero in late 2008 and more than tripled the size of its balance sheet, to $3.7 trillion, via three rounds of massive bond purchases aimed at holding down long-term borrowing costs.

Kocherlakota dismissed worries about the eventual exit from the Fed's ultra-easy measures, saying that the question of how to normalize monetary policy has been "studied to death" within the Fed.

"We know about it. We have a great deal of confidence, based on our staff work, about how that is going to work," he told an audience in Bloomington, Minnesota.

LACKER UNSWAYED ON NEED TO TAPER

The Fed surprised financial markets last month when it voted to maintain its $85 billion monthly pace of bond purchases, saying it wanted to see more evidence of solid economic growth.

The outlook for a scaling back bond purchases has grown cloudier since the budget battle in Washington hit a stalemate and forced a partial government shutdown.

The shutdown, which entered its fourth day on Friday, is courting a damaging debt default if lawmakers fail to raise the U.S. debt ceiling by Oct. 17.

Officials, including at the Fed, warn that a debt default could potentially tip the United States into a severe recession if it shakes confidence in the ability of U.S. lawmakers to lead the country.

But while the uncertainty created by the political gridlock in Washington has helped vindicate the Fed's unexpected caution, some U.S. policymakers remain unswayed about the need to scale back the bond buying.

Jeffrey Lacker, president of the Richmond Federal Reserve and a hawk on inflation, said he would have tapered in September, regardless of the looming shutdown.

"If you had told me a two-week shutdown was coming I would have favored tapering in September anyway," he told reporters after a speech in Baltimore.

"Federal Reserve policies cannot necessarily counteract the effects of fiscal policy uncertainty, declining productivity growth or structural changes in the labor market - all of which appear to be playing a role to some degree," said Lacker, who does not have a vote on Fed policy this year.

HAWKS AND DOVES

Lacker and Kocherlakota were among a number of Fed officials commenting about monetary policy on Friday.

Boston Fed chief Eric Rosengren, another dove, also weighed into the debate, telling the Washington Post that he favored considering additional measures to keep interest rates lower.

The Fed is pondering how to enhance its forward guidance on when it would start raising rates. At the moment, it has committed to hold rates near zero until unemployment hits 6.5 percent, provided the inflation outlook stays under 2.5 percent.

The jobless rate in August fell to 7.3 percent, a 4-1/2-year low. The Labor Department did not release data for September on Friday, as originally scheduled, because of the government shutdown.

Some officials favor adding an additional threshold that inflation remain above 1.5 percent. Others, including Kocherlakota, have pushed for a lower unemployment threshold to convince markets that they will keep policy easy, even after the economy recovers.

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