* With low rates, signs of financial instability inevitable
* Keep economy at appropriate temperature, Fed official says
By Jonathan Spicer and Leah Schnurr
NEW YORK, April 18 The Federal Reserve's ultra
accommodative policies will inevitably result in financial
market instability for years but such risks are necessary to
boost employment and inflation, a top U.S. central bank official
said on Thursday.
Likening the Fed to a Minnesotan heading out into the winter
cold, Minneapolis Fed President Narayana Kocherlakota said low
real interest rates are as necessary as wearing a warm parka,
and will probably be needed for many more years.
Kocherlakota is probably the most dovish of the 19
policymakers at the Fed, which has kept borrowing costs low for
more than four years and is snapping up $85 billion in bonds
each month to stimulate the U.S. economic recovery.
Bolstering his argument for yet more easing, the Minneapolis
policymaker said the weak economic outlook suggests borrowing
costs should be lower for even longer than the Fed now plans
despite the inflated asset prices, volatile returns, and higher
corporate merger activity that will result.
"For many years to come," he said, the Fed's policy-setting
committee "will only be able to achieve its congressionally
mandated objectives by following policies that result in signs
of financial market instability," Kocherlakota told a Hyman P.
Financial regulation is the best defense against such
instability, he said.
But if the Fed considers raising rates to stabilize things,
it has to weigh "the certainty of a costly" departure from
achieving maximum employment and price stability against the
benefit of reducing "the probability of an even larger"
departure those objectives, Kocherlakota warned.
Central bank policymakers would also have to consider the
effect a sooner-than-desired rate-rise would have on the Fed's
overall credibility, he later told reporters. "That's going be
part of the question you have to ask yourself," he said.
Frustrated with the slow and erratic recovery, the central
bank has said it will keep short-term rates low until the
unemployment rate falls to at least 6.5 percent, from 7.6
percent last month, as long as inflation, now below the Fed's
2-percent target, remains contained.
Meanwhile the Fed's bond-buying is meant to depress longer
term rates and encourage investing, hiring and economic growth.
Kocherlakota is alone among policymakers in wanting the
central bank to aim to keep rates low until unemployment falls
as low as 5.5 percent, a level to which Americans are more
Kocherlakota, whose hometown is expecting yet another spring
snowfall, said the policy-setting Federal Open Market Committee
(FOMC) is responding to forces beyond its control when it
decides how long to keep rates low, given it is falling short of
both its employment and inflation goals.
"When I decide what coat to wear, my goal is to keep myself
at a temperature that I view as appropriate, given prevailing
conditions that I cannot influence," he said.
"Similarly, when the FOMC decides on a level of the real
interest rate, its goal is to keep the macro economy at an
appropriate temperature, given prevailing conditions that it
cannot influence," he added. "But the truth is that the FOMC's
choice of winter garb is actually insufficient to keep the U.S.
economy appropriately warm."
Talking to reporters, he did not go so far as to call for
more asset purchases. But he said it was very important that the
Fed protects its 2-percent inflation target "both from above,
which gets so much attention, but from below as well."
On Wednesday, St. Louis Fed President James Bullard
surprised some economists when he said the central bank should
ramp up its quantitative easing program if inflation continues
to fall. According to the Fed's preferred measure, inflation is
at about 1.3 percent.
In his speech, Kocherlakota added he expects credit markets
will remain limited over the next five to 10 years, causing
headaches for investors seeking safe-haven assets.