ST. PAUL, Minnesota Given how slowly the Federal Reserve expects U.S. joblessness to decline, the central bank should be ramping up, not dialing back, its efforts to stimulate the economy, a top Fed official said on Tuesday.
The Fed has been buying $85 billion each month in Treasuries and mortgage-backed bonds to push down long-term borrowing costs in order to boost investment and hiring. Over the past several months, investor speculation has centered around when and how quickly the Fed's policy-setting committee will cut the program.
"Reducing the flow of purchases in the near term would be a drag on the already slow rate of progress of the economy toward the committee's goals," Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank and one of the Fed's most dovish policymakers, said in remarks prepared for delivery to the St. Paul Chamber of Commerce.
The Fed forecasts that the unemployment rate, now at 7.3 percent, will decline gradually, and the inflation rate will be below the Fed's 2 percent goal over the medium term.
"Under a goal-oriented approach, the committee would respond to this weak outlook by providing more monetary stimulus -- for example, by lowering the interest rate being paid to banks on their excess reserves," Kocherlakota said.
In fact, he said, repeating a theme he has hammered home in at least three speeches since September, the Fed should do "whatever it takes" to bring the economy back to full employment quickly, even if it means pushing inflation temporarily above the Fed's goal.
In June Fed Chairman Ben Bernanke pointed to improvements in the labor market since the bond-purchase program began last September and suggested the purchases could be brought to a close by mid-2014.
Bond yields soared in response, as investors began pricing in a quicker return to normal levels of short-term interest rates, which the Fed has kept near zero since December 2008.
Bond yields fell and stocks rose after the Fed's unexpected decision in September to keep the program in place to shore up the economy in the face of disappointing job gains and a fierce Washington budget battle that ultimately partially shut down the U.S. government for 16 days in October.
Kocherlakota said the Fed's decision to keep up with its bond-buying is informed not only by the Fed's economic outlook but by its view of the costs and the effectiveness of the program. But because discussion of the potential for winding down the program is typically cast only in terms of the economic outlook, the Fed risks creating a perception that it is not focused on goal-oriented monetary policy, he said.
"Such a perception can create doubts and uncertainty about the criteria underlying committee decisions," Kocherlakota said, citing heightened bond-market volatility in the past few months as evidence that such doubts are in place.
"I believe that the committee could reduce this volatility by greatly enhancing its communication on the role of cost and efficacy considerations in its deliberations about the evolution of asset purchases."
Kocherlakota, who regains a vote on the Fed's policy-setting panel next year, reiterated his proposal for the Fed to keep interest rates low until unemployment falls to 5.5 percent, a level that many economists view as "full" employment.
The Fed currently promises to keep rates low until unemployment has fallen to at least 6.5 percent, and a widely noted Fed paper recently outlined an argument for lowering that threshold further.
(Writing by Ann Saphir; Editing by Leslie Adler)