Fed's Kohn says policy gets made with eye to risks

WASHINGTON (Reuters) - Monetary policy makers must sometimes set interest rates with an eye to risks, not just ideal levels of inflation and economic growth, Federal Reserve Vice Chairman Donald Kohn said in a speech on Friday.

Kohn's speech did not touch on the outlook for the economy or interest rates.

Kohn said it is no surprise the simple rule devised by Stanford University economist and former Treasury Department undersecretary John Taylor for helping central bankers decide how to set interest rates has been well received among academic economists and policy makers.

The Taylor rule says central banks should adjust interest rates based on the gap between actual economic growth and how fast the economy can grow without kindling inflation and the deviation between actual inflation and the central bank's target inflation rate.

The rule "provides a plausible template for future success" for policy makers in keeping an economy growing steadily without igniting inflation, Kohn said in remarks prepared for delivery to a conference on Taylor's work organized by the Dallas Fed.

But a simple rule like Taylor's has its limitations, Kohn added. It uses a single measure of inflation and a small number of variables and does not take into account policy makers' risk-management considerations.

"In some circumstances, the risks to the outlook or the perceived costs of missing an objective on a particular side may be sufficiently skewed that policy makers will choose to respond by adjusting policy in a way that would not be justified solely by the current state of the economy or the ... outlook for output and inflation gaps," Kohn said.