NEW YORK The Federal Reserve must remain very accommodative because the labor market remains far from healthy despite some recent improvement in the broader economy, an influential U.S. central bank official said on Monday.
New York Fed President William Dudley, a close ally of Fed Chairman Ben Bernanke, gave a strong and comprehensive speech defending the very easy monetary policies that he said were gaining traction and must not yet be adjusted.
"We need to keep monetary policy very accommodative," Dudley told The Economic Club of New York. "I see greater cost and risk in moving prematurely to a policy setting that might not prove sufficiently accommodative to ensure a sustainable, strengthening recovery."
The wide-ranging speech suggests that the Fed's dovish core - including Bernanke, Dudley and Fed Vice Chair Janet Yellen - remain steadfastly committed to easy policies despite stronger data on the jobs market, including a drop in the unemployment rate to 7.7 percent last month.
One by one, Dudley knocked down many of the concerns critics have raised over the Fed's program of buying $85 billion in bonds per month, going so far as to say the efficacy of the quantitative easing program (QE3) has been higher than he expected at the outset.
He also zeroed in on tighter U.S. fiscal policies, including tax hikes and sharp spending cuts enacted for this year, as a stumbling block that he predicted would shave 1.75 percentage points from U.S. GDP growth this year.
The "fundamentals underpinning the U.S. economy are improving and monetary policy is gaining additional traction," Dudley said in his first public comments on policy since November. "But this may not immediately lead to stronger growth because of the recent increase in fiscal restraint."
Bernanke, speaking to a group of academics in London on Monday, defended the U.S. central bank's monetary policies from a more international perspective. While the aggressive easing was aimed at bolstering the U.S. economy, Bernanke said, the integrated nature of the world economy meant such policies were benefiting other countries as well.
"Because stronger growth in each economy confers beneficial spillovers to trading partners, these policies are not ‘beggar-thy-neighbor' but rather are positive-sum, ‘enrich-thy-neighbor' actions," he said.
U.S. retail sales and manufacturing activity have markedly improved in recent months, though the fiscal tightening, as well as renewed market turmoil out of Cyprus and Italy, reinforced how vulnerable remains the slow and erratic U.S. recovery from the 2007-2009 recession.
'FED IS NOT AN ASSET MANAGEMENT COMPANY'
The purchases of Treasury and mortgage bonds are meant to reduce longer-term borrowing costs and spur spending, investment and hiring in the broader economy. The Fed has kept interest rates near zero since 2008 and intends to keep them there until the unemployment rate drops to 6.5 percent or so.
Stronger jobs growth has helped lower the unemployment rate to 7.7 percent last month from 7.9 in January. Joblessness was as high as 10 percent in 2009.
Though Fed policymakers decided last month to continue with QE3 at it current clip, some Fed policymakers worry that the massive buying will destabilize financial markets, feed asset bubbles or set the stage for a run up in inflation.
Bond yields have edged higher this year as investors anxiously try to predict when the central bank will taper the level of purchases or stop the program altogether.
But for Dudley, that time is not now.
"It is premature to conclude that we will soon see a substantial improvement in the labor market outlook," he said, adding the amount of purchases would respond to "material changes" in that outlook.
He cautioned against putting too much stock in the recent gains in employment, noting that there remains "substantial" slack the labor market that still is "far from healthy." The U.S. employment-to-population ratio and job-finding rates, he added, "are essentially unchanged" from earlier in 2012.
Dudley also sought to tamp down speculation that the Fed's balance sheet - now worth more than $3 trillion - could rack up losses if the central bank eventually begins to sell off assets.
He said the focus should be helping the economy without worrying about possible losses down the road. "The Fed is a central bank, not an asset management company," Dudley said to some laughter from the audience.
Turning to the economy, Dudley said he expects annualized growth of 2-3 percent in the first quarter of this year, but "sluggish" growth in the first half due to the fiscal drag.
(Reporting by Jonathan Spicer; Editing by Chizu Nomiyama)