| JACKSON HOLE, Wyo.
JACKSON HOLE, Wyo. Aug 23 The biggest risk
facing the U.S. economy is a premature policy tightening by the
Federal Reserve, officials were warned on Friday in the opening
paper at the prestigious Jackson Hole symposium.
The annual conference, hosted by the Kansas City Federal
Reserve Bank in the mountains of Grand Teton National Park,
gathers central bankers from around the world and provides an
update on the latest thinking among top monetary economists.
Stanford University economist Robert Hall, in a paper titled
"The Routes Into and Out of the Zero Lower Bound," concluded
that U.S. economic growth and hiring were slowly heading back to
normal, but that the Fed must maintain an ultra-easy policy to
keep the recovery on track.
"The central danger in the next two years is that the Fed
will yield to intensifying pressure to raise interest rates and
contract its portfolio well before the economy is back to
normal," he wrote in the 31-page paper.
The U.S. central bank has held overnight rates near zero
since December 2008 and has more than tripled its balance sheet
to around $3.6 trillion through a series of bond purchase
programs aimed at driving other borrowing costs lower.
Economists have traditionally watched the opening morning of
the Jackson Hole conference for a signal on future Fed policy
But the decision by Fed Chairman Ben Bernanke to stay away
this year means there are no remarks scheduled from any of the
top Fed officials attending, including Fed Vice Chair Janet
Yellen, who will chair a policy panel on Saturday.
Absent a keynote Fed speaker, Hall's paper opened the
conference, which will also hear presentations on the latest
evidence on the impact of quantitative easing, as well as
cross-border capital flows and global liquidity - both hot
topics given a big sell-off in emerging market currencies in
anticipation of a reduction in the Fed's bond-buying stimulus.
Hall argued that the tools central banks in the United
States, Japan and Europe have to boost growth while inflation is
low and interest rates near zero are weak. That helps explain
why U.S. unemployment was still so high and the economy so
tepid, despite five years of massive monetary stimulus, he said.
"The worst step the Fed could take would be to raise the
interest it pays on reserves," he said, referring to the main
tool the Fed plans to use to eventually mop up the cash it has
pumped into financial markets.
The U.S. central bank has said that any move to raise
borrowing costs is still a long way off. In projections released
after a meeting in June, the Fed said that 14 of its 19
policymakers did not think a rate rise should occur until 2015.
That said, the Fed does expect to begin reducing its current
$85 billion a month bond-buying pace later this year, and
financial markets are betting the first reduction will come at
the Fed's next meeting on Sept. 17-18.
Officials have gone out of their way to assure markets that
any scaling back of their so-called quantitative easing, or QE,
would not be a signal that their commitment to hold rates near
zero for a considerable period is faltering.
Indeed, it has cemented its rate pledge by stating that it
would not start to even think about raising rates until the
unemployment rate has fallen under 6.5 percent, provided
inflation does not look likely to rise above 2.5 percent. The
jobless rate stood at 7.4 percent in July, while consumer prices
have risen just 1.3 percent in the 12 months through June.
Hall was bluntly dismissive of the impact of both QE and
this so-called forward guidance on rates.
"Both quantitative easing and forward guidance, as
implemented by the Fed, are obviously weak instruments," he
said, pointing to the failure of the U.S. economy to rebound
strongly despite prolonged easy policy as evidence.
The problem lies in the inability of policymakers to drive
inflation-adjusted interest rates sufficiently into negative
territory when nominal rates are already at zero.
If inflation is only hovering around 1 percent, real rates
cannot be driven lower than minus 1 percent, even though
economic models demand a much deeper negative real rate to spur
the spending needed to get the economy growing more vigorously.
The good news is that "most of the developments that led the
United States and other advanced economies into zero lower bound
slumps are self-correcting," said Hall. He noted that
deleveraging by U.S. households and companies looked to be
subsiding, and that higher stock markets were encouraging
investment by lifting the risk premium for business income.
"The major potential exception to the good news is the hint
of a move toward deflation," he said, noting that inflation
remained well below the Fed's 2 percent target.