(Adds Tarullo remarks, market analyst comment)
By Pedro Nicolaci da Costa
WASHINGTON, March 26 The Federal Reserve's
unprecedented dose of stimulus to the economy during the recent
financial crisis complicates the task of pulling back when the
time is right, top central bank officials said on Friday.
Fed Board Governor Kevin Warsh argued that tame inflation
readings today should not make policy makers complacent about
the risk of future price increases.
"Inflation expectations will be anchored until they are
not," Warsh said in a speech in New York. "Central bankers
would be prudent to keep a very open mind about shocks that
could happen domestically and overseas."
Ben Bernanke, the Fed chairman, told Congress on Thursday
that the central bank is aware of such risks and has the tools
necessary to withdraw monetary stimulus in time.
These include direct open market operations to drain
reserves, raising the interest the Fed pays on excess bank
reserves parked at the central bank, and outright sales of some
of the nearly $1.5 trillion in mortgage-related assets the Fed
committed to buying over the course of the crisis.
In an effort to combat the worst financial crisis in
generations, the Fed not only slashed interest rates
effectively to zero percent but also embarked on an
unprecedented emergency program of asset purchases aimed at
keeping borrowing costs low and cushioning the housing sector.
A small group within the Fed, mostly presidents of some
regional Federal Reserve banks, has shown discomfort with this
unorthodox policy, arguing it borders on fiscal policy and
could make removing liquidity from the system difficult.
Charles Plosser, president of the Philadelphia Fed, said on
Friday in an interview with The Wall Street Journal it might be
prudent for the Fed to sell some of its mortgage assets before
raising interest rates to make policy more effective.
In the past, Plosser has gone as far as suggesting the Fed
should undertake a swap of mortgage assets with the Treasury
Department so that its portfolio can return to being primarily
composed of sovereign bonds rather than private debt.
"Given the market functioning, I don't anticipate that
selling MBS at a reasonable pace is going to have a tremendous
impact on mortgage rates," Plosser said.
HOUSING, GREECE WILDCARDS
But James Bullard, president of the St. Louis Fed who has
also advocated asset sales as a potential early step in the
Fed's exit, said recent weakness in housing data was giving him
Sales of newly built U.S. homes fell for a fourth straight
month in February to a record low annual rate of 308,000
"It's making me nervous," he told Reuters on the sidelines
of a conference sponsored by the Fed. "I will be interested in
seeing the (upcoming) data, and if that begins to not look
good, then I'll start to wonder."
Bullard said he does not foresee any sharp rebound in
housing activity, adding that a stabilization in prices and
sales would be enough of a signal that selling assets would not
be too disruptive. He said the U.S. economy is on track for a
Market analysts appear convinced that asset sales will not
be the Fed's preferred method for withdrawing stimulus.
"We believe a plan to sell Fed assets is still a long ways
off," said Joseph Abate, money market strategist at Barclays
Asked about the crisis affecting Greece, whose heavy
indebtedness has sparked widespread fears of renewed financial
turmoil, Bullard was cautiously optimistic.
"So far I think we're OK. I wouldn't want to play it down
too much," he said. "We played down other things too much
during this crisis, and it came back to bite us. So, we're
watching it very carefully. But right now I don't see it having
any feedback to the U.S."
These actions have led to a sharp rise in Fed credit to the
banking system, which some economists worry has the potential
to ignite future inflation, or at the very least, complicate
policy makers' task of removing monetary accommodation. Such
outstanding reserve credit, often referred to as the Fed's
balance sheet, now stands at a record $2.3 trillion.
"The Fed, as first responder, must strongly resist the
temptation to be the ultimate rescuer," Warsh said.
At the Fed's conference, Bullard asked one economist
presenting a paper, Columbia Professor Michael Woodford,
whether he believed the central bank would have to drain
reserves even as it raises interest rates in order for rates to
Woodford argued that such operations were not strictly
necessary. Those advocating them are being "excessively
cautious," he said.
In separate remarks on Friday, Fed Board Governor Daniel
Tarullo focused on regulation, his principal purview at the
He argued that public disclosure of bank stress test
results last year helped rescue the global financial system,
and regulators should weigh some level of transparency in
Congress is considering various versions of financial
regulatory reform, some of which might reduce the Federal
Reserve's role over policy. Many fault the Fed for loose
oversight that allowed dubious practices in both banking and
housing to thrive, leading to the financial crisis.
But Tarullo argued the Fed has reformed its ways,
fine-tuning the way it supervises banks to include possible
risks to the system as a whole, looking beyond the individual
conditions of specific institutions.
As for releasing future stress test results, Tarullo cited
pros and cons. One risk would be that fears about potentially
troubled banks might be self-fulfilling.
(Additional reporting by Emily Kaiser, Kristina Cooke and
Steven C. Johnson; Editing by Kenneth Barry and Leslie Adler)