Bad fiscal policy, politics are a threat: central bankers

MEXICO CITY Tue Oct 15, 2013 5:16pm EDT

MEXICO CITY (Reuters) - Fiscal policy and politics risk undermining the efforts of central bankers to revive the global economy, top central bank officials warned on Tuesday, as a potentially devastating debt default loomed in the United States.

Washington is locked in a bitter budget battle that has partially shut down the federal government. The U.S. Federal Reserve has repeatedly warned that the impasse creates serious headwinds for growth and hiring and could inflict another recession if it triggers a U.S. default.

While there was progress in talks, a deal was still far off, the White House said.

New York Fed President William Dudley told a panel in Mexico City that massive bond buying by the U.S. central bank might potentially undermine its independence if this led to losses on its balance sheet when interest rates rise.

"While the threat is low, central bankers need to be cognizant of such risks, and clearly explain the motivations for their actions in order to mitigate such risks," he said in remarks prepared for a conference hosted by the Bank of Mexico.

"A far more important threat to central bank independence than the use of unconventional monetary policy is whether the fiscal authorities act in a manner consistent with the central bank's objectives," he told participants at the event on unconventional monetary policy and central bank independence.

Europe is also feeling pressure, with governments losing a lot of sovereignty to financial markets, European Central Bank (ECB) governing council member Klaas Knot said, adding it was imperative to protect central bank independence.

"Central banks' balance sheets are becoming more and more exposed to economic risk and political pressure," Knot told the conference.

"Eventually, this may result in a substantial amount of negative capital in a central bank's balance sheet. This is undesirable because it could undermine a central bank's credibility."

U.S. senators voiced hope a bipartisan deal could emerge on Tuesday to end Washington's fiscal crisis even as Republicans in the House of Representatives proposed their own plan, which the White House dismissed.

Even if Democrats and Republicans agree, it could be Wednesday before the U.S. Senate signs off on a plan, senators said, close to a Thursday deadline when the Obama administration says it will reach its borrowing limit and risk default.

"We are all worried and all hoping that the problem will be resolved soon," Mexican central bank governor Agustin Carstens said.

EASY MONEY

The Fed has been harshly criticized by some Republican lawmakers for an unprecedented 5 years of ultra-easy monetary after it slashed interest rates to near zero in late 2008 and quadrupled its balance sheet to around $3.7 trillion through bond purchases aimed at holding down borrowing costs.

Dudley said the Fed might suffer losses on these holdings because a rise in interest rates could reduce, or even wipe out, the amount it pays back to U.S. taxpayers every year.

This might expose the Fed to political pressure if the loss forced it to ask Congress for more money. But Dudley said that problem could be avoided by creating a "deferred asset" on its balance sheet, which would preserve its budgetary independence.

(With reporting by Alexandra Alper and Luis Rojas in Mexico City and Alister Bull in Washington; Writing by Alister Bull and Simon Gardner; Editing by Chizu Nomiyama and Andre Grenon)

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