UPDATE 1-Fed's George still uneasy about Fed's easy policies

Thu Jan 9, 2014 2:56pm EST

By Brendan O'Brien

MADISON, Wisc. Jan 9 (Reuters) - The Federal Reserve's decision to dial down its enormous bond-buying program is a small but positive step toward a more normal interest-rate environment, a top Fed official who has long opposed the policy said on Thursday.

But the fact that the Fed continues to buy assets and plans to keep interest rates near zero for the foreseeable future is still cause for worry, according to Kansas City Federal Reserve Bank President Esther George.

"Monetary policy is likely to remain highly accommodative for some time with additional -- albeit reduced -- levels of bond-buying under the current program and an extended period of low interest rates," George told the Wisconsin Bankers Association. "I will tell you, I remain concerned about the potential costs and consequences of these untested policies."

The Fed has kept interest rates near zero for more than five years. George said she was particularly uncomfortable with the Fed's promise to keep them there until well past the time that unemployment, now at 7 percent, falls another half a percentage point.

"We can't know today and make commitments to that point, in my view, that respect how the economy is unfolding," she told the bankers. "If we become too focused on current data measures as opposed to watching the longer-term trends, then I fear we may wait too long to move rates."

In addition to keeping rates low, the U.S. central bank has bought trillions of dollars of Treasuries and mortgage-backed securities, pushing down long-term borrowing costs in an effort to spur hiring and investment.

George consistently used her vote on the Fed's policy-setting panel last year to protest that program, known as quantitative easing, citing her worries that it could fuel future inflation.

Last month, citing the improvement in the economy, Fed Chairman Ben Bernanke led the panel in a decision to pare the program to $75 billion a month from $85 billion. He also said the central bank expects to wind the program down completely by late 2014, but took pains to assure investors the Fed will be patient on raising rates.

George voted in support of the move, but on Thursday made clear she is far from comfortable with the Fed's current stance.

"An extended period of zero interest rates is not conducive to good banking and encourages a reach for yield," she said.

George said she expects the U.S. economy to grow about 2.5 percent to 3 percent this year, as fiscal headwinds abate and the job market improves.

While several of her colleagues have worried publicly about inflation running well below the Fed's 2-percent target, George said she does not share those concerns, and attributed low inflation to special factors like lower-than-usual healthcare costs and low import prices.

The regular voting rotation on the Fed's policy-setting panel means that George will lose her vote this year, but she will nevertheless participate in policy discussions. The Fed next meets late this month.

"Each time the Federal Reserve meets we are going to be looking at how the economy continues to improve and be making decisions at each meeting accordingly," she said.

George used much of her speech to advocate for policy changes that could reduce the threat from so-called "too-big-to-fail" banks, and suggested that one possibility is to adopt a modern version of the Glass-Steagall Act that prevented banks from reaching into non-bank businesses.

"In the near-term, timely shifts in monetary policy and better calibration of regulatory requirements may offer potential relief to smaller banks," she said, but for the longer-term, ending too-big-to-fail through policy change is key to a healthy economy.

FILED UNDER: