The Federal Reserve's decision to ratchet down its massive bond-buying program was a "modest but positive step," a top Fed official said on Friday, but continued super-easy monetary policies pose risks both at home and abroad.
"I remain concerned that continuation of these policies could have significant long-term costs," Kansas City Federal Reserve President Esther George said at a Basel Committee/Financial Stability Institute high-level meeting in Cape Town, South Africa, according to written remarks released by the regional Fed bank.
Already, she said, there are signs that banks are "chasing yields," building up risky bets that could threaten financial stability longer term, she said. And the destabilizing effects of super-easy policies are not confined to the countries, like the United States, that pursue them, she said.
"Such policies can influence other countries by distorting their exchange rates and balance of payment positions, capital flows and rates of credit expansion," she said.
George has been a stalwart opponent of the Fed's bond-buying program. Last year she consistently cast her vote against the Fed's policy on this until the final meeting in December when the U.S. central bank decided to begin winding it down.
Although George has no vote this year - regional Fed bankers pass the balloting baton on monetary policy each January - she is not alone in warning against unseen and negative side effects of the Fed's unprecedented policies.
The Fed's bond purchases, aimed at pushing down borrowing costs and boosting investment and hiring, have swollen the Fed's balance sheet to $4 trillion.
The Fed has also kept benchmark interest rates near zero for more than five years and has promised to keep them there until well past the time that the U.S. unemployment rate, now at 6.7 percent, falls to 6.5 percent, so long as inflation remains in check.
On Wednesday, it took another step toward ending its bond-buying program by cutting purchases to $65 billion monthly, despite recent turmoil in emerging markets that some had speculated would prompt the Fed to put its wind-down on hold.
But the program still adds considerable stimulus to the U.S. economy, and is risky, George said.
"As central banks undertake unprecedented actions to alter rates and prices in financial markets, we should not be surprised to find unintended, negative side effects," George said on Friday. Sharp rises in U.S. stocks .SPX and farmland prices could be signs of asset bubbles, she suggested.
To counteract the negative effects of easy policy, George urged stronger supervisory action, including strengthening bank capital through higher leverage ratios.
Restrictions like the controversial 'Volcker rule' in the United States, which limits proprietary trading by banks, also offer a potential solution, along with careful oversight of banks to detect problems such as lax lending standards and poor governance before they balloon.
"To the extent similar weaknesses emerge as an outgrowth of current monetary policies and risk appetites, strong examination processes are a critical element in flagging such risks at the firm level," George said. "However, limiting the conditions or incentives for risk-taking and their broader effects on financial stability must be recognized as beyond the scope of supervision."
(Reporting by Ann Saphir; Editing by Chizu Nomiyama and James Dalgleish)