BOSTON, June 5 The Federal Reserve should keep
U.S. borrowing costs low for another five years to ensure the
economy returns to health, even if doing so generates worrying
signs of financial instability, a top U.S. central bank
policymaker said on Wednesday.
With the current outlook suggesting U.S. inflation and
employment will undershoot the Fed's goals for years to come,
"the (Fed) will only be able to meet its objectives over that
time frame by taking policy actions that ensure that real
interest rates remain unusually low," Minneapolis Fed President
Narayana Kocherlakota said in remarks prepared for delivery to
Boston College's Carroll School of Management.
For "possibly the next five years or so," he added, the Fed
may need to keep real interest rates as much as two-percentage
points below its 2007 level of 2.5 percent.
One of the Fed's most dovish policymakers, Kocherlakota has
pushed strongly for more accommodative monetary policy in the
face of unemployment that remains well above normal levels, and
inflation that remains well below the Fed's 2-percent goal.
With Wednesday's speech, Kocherlakota appeared to be pushing
the envelope considerably further, calling for rates to stay low
well beyond the timeframe envisioned by most of his colleagues,
and suggesting that, at least for the time being, the costs of
raising rates to reduce vulnerabilities in the financial system
are much greater than the benefits.
Real interest rates, which subtract out inflation, are
currently below zero, but are set to rise once the Fed starts
raising interest rates, probably sometime next year.
Kocherlakota acknowledged that keeping rates low for so long
can lead to conditions that signal financial instability,
including high asset prices, volatile returns on assets, and
frantic levels of merger activity as businesses and individuals
strive to take advantage of low interest rates.
But that is a risk, he suggested, the Fed should be willing
"For a considerable period of time, the (Fed) may only be
able to achieve its macroeconomic objectives in association with
signs of instability in financial markets," he said.
The Fed should address those risks with regulatory and
supervisory tools, because the risks of using the "blunt" tool
of monetary policy - for instance, by raising rates - has clear
and large costs and few clear benefits, he said.
That calculus, Kocherlakota said, will change over time, and
as the economy heals the Fed will need to navigate an ever more
difficult balance between boosting the economy and risking
bubbles and other potential crises-in-the-making.
The Fed has said it expects rates to be below their
historical norms even after unemployment and inflation return
nearer to healthy levels.
At that juncture, Kocherlakota said, "I anticipate that
financial stability considerations are likely to play a
substantial role in the determination of the appropriate level
of monetary accommodation."
(Reporting by Richard Valdmanis; writing by Ann Saphir; Editing
by Chizu Nomiyama)