November 18, 2010 / 9:11 PM / 7 years ago

Fed officials circle wagons around QE2

CHICAGO (Reuters) - Two top Federal Reserve officials on Thursday rallied around the central bank’s $600 billion bond buying plan, which has drawn fire from U.S. lawmakers and foreign capitals alike.

Minneapolis Federal Reserve Bank President Narayana Kocherlakota said he backed the decision, a surprise endorsement from a policymaker who had been skeptical of the impact of further monetary easing.

“I believe that QE (quantitative easing) is a move in the right direction,” he told a conference of tax professionals in Chicago.

Cleveland Fed chief Sandra Pianalto also defended the plan as a way help lift “uncomfortably low” inflation to fend off the risk of a debilitating broad drop in prices.

The Fed’s November 3 decision, aimed at combating persistently high unemployment and the threat of deflation, has been attacked by governments around the world which are anxious it may weaken the U.S. dollar and undermine their exports.

The Fed has also recently been a target for U.S. Republican politicians and economists with ties to the party who say it could ignite inflation.

The attacks have led the Fed to circle the wagons. Fed Chairman Ben Bernanke huddled behind closed doors with U.S. lawmakers on Wednesday, while Vice Chair Janet Yellen and New York Fed President William Dudley have given rare on-the-record interviews to make the central bank’s case.

Bernanke is expected to deliver a public defense in remarks at a conference in Frankfurt on Friday.

The U.S. central bank cut overnight borrowing costs to near zero in December 2008, and bought $1.7 trillion in longer-term securities after that to help pull the economy out of recession.

The asset buying is known as quantitative easing because the Fed aims to stimulate the economy by pumping vast amounts of money into the financial system now that it can no longer lower overnight rates. The new round of bond-buying is often referred to as “QE2”.

EFFECTS MODEST BUT WORTH IT

Kocherlakota, who rotates into a voting slot on the Fed’s policy panel next year, said he expects the ultimate effects of the latest program to be relatively modest, but that the effort was worthwhile given sluggish growth and the low level of inflation.

“I think it is safe to say that, given the situation, the (Fed) would have liked to have been able to cut its target interest rate,” he said.

He said the program will lower longer-term interest rates by strengthening the Fed’s stated commitment to keeping short-term rates low for a long period. Longer term rates encompass investors’ views of where short-term rates will be in the future.

“QE provides a significant supplement to this explicit verbal communication,” he said. “One could readily argue that buying $600 billion of Treasuries is a much more convincing form of communication of the (Fed‘s) plans than any words could ever be.”

Similarly, Pianalto, a Fed voter this year, said it was important to innoculate the U.S. economy from the type of deflationary outcome that has afflicted Japan.

“Responding to inflationary and disinflationary pressures gets to the heart of what a central bank can and must do,” she told an audience at Case Western Reserve University in Cleveland.

Another Fed official, Fed Governor Kevin Warsh did not offer explicit backing for the easing program, saying monetary policy has an important, but not a predominant, role to play in pushing the economy into higher gear.

Instead, he argued that greater certainty in terms of fiscal, trade and regulatory policies would do more to spur business activity.

Warsh, who voted for the new policy, said last week the program should be curtailed if the economy were to accelerate or if signs the policy was backfiring began to emerge, but other policy-makers have made clear they expect the Fed to follow through with the full $600 billion of purchases.

Warsh, who worked as an aide to former Republican President George W. Bush, questioned calls from Republican lawmakers to alter the Fed’s mandate by removing the requirement that it pursue full employment and leaving it with only a price stability directive.

The debate could keep lawmakers from addressing the uncertainties holding back business spirits, he told business executives in Chicago.

“If it were to take oxygen away from what I believe are much more pressing issues,” Warsh said, “it strikes me as not seizing the window of opportunity.”

Additional reporting by Ann Saphir in Chicago; editing by Clive McKeef

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