Lacker urges limits on Fed's credit market 'activism'

PALO ALTO, Calif. Fri May 30, 2014 2:00pm EDT

PALO ALTO, Calif. May 30 (Reuters) - A top Federal Reserve official warned that intervention in credit markets could undermine central bank independence, and called for the imposition of "credible limits" on such activism.

"Entanglement in the distributional politics of credit allocation inevitably threatens the delicate equilibrium underlying central bank independence, which has been so essential to monetary stability," Richmond Fed President Jeffrey Lacker said in remarks prepared for delivery to Stanford University's Hoover Institution.

To drive home his point, Lacker pointed to the 1970s, when the Fed not only allowed inflation to get out of hand as it focused on bringing down unemployment, but also failed to resist pressure to buy federal agency debt.

As a result, he said, by 1977 the Fed owned $117 million in debt issued by Washington DC's transportation authority, "with the bizarre result that the Fed wound up financing the construction of the Washington Metro."

Lacker has long criticized the Fed for engaging in credit allocation, including some of its actions during the financial crisis to rescue failing financial institutions.

To Lacker, the Fed had set up expectations long before the crisis that it would bail out distressed institutions when needed, and that it needs to end those expectations before financial stability can be restored.

"Establishing credible limits to central bank intervention in credit markets is critical to central banks' core monetary policy mission," he said. (Reporting by Ann Saphir; Editing by Chizu Nomiyama)

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