By Ann Saphir
LOS ANGELES, April 3 The U.S. Federal Reserve could begin to cut back on its massive bond-buying program this summer if the economy continues to pick up steam, a top Fed official said on Wednesday, a sign of growing optimism within the Fed that its unprecedented policies are working.
The Fed is buying $85 billion in Treasuries and mortgage-backed securities each month to push down long-term interest rates and encourage hiring, and has vowed to continue the program until there is substantial improvement in the labor market outlook.
"Assuming that the economy gains more momentum in the next year or two, I expect we will meet the test for substantial improvement in the outlook for the labor market by this summer. If that happens, we could start tapering our purchases then," San Francisco Federal Reserve Bank President John Williams told Town Hall Los Angeles. "If all goes as hoped, we could end the purchase program sometime late this year."
Williams repeated his earlier view that asset purchases will probably be needed well into the second half of the year, but also warned against over-stimulating the economy, and emphasized the need to "lighten up on the accelerator a bit" as headwinds to recovery wane.
"Eventually, if we find ourselves picking up too much speed, we may need to apply the brakes," he said.
Williams' change in tone is notable.
Policy centrists like Williams have consistently supported Chairman Ben Bernanke's efforts to stimulate the economy. It is a shift their views, rather than the continued criticism of monetary easing by policy hawks, that could push the Fed to alter its stance.
Upbeat data in recent months, including on the labor market, has suggested the economy picked up in the first quarter after growing at a weak 0.4 percent rate in the fourth quarter of last year.
The stronger outlook prompted centrist Cleveland Fed President Sandra Pianalto last week to suggest the Fed begin to think about cutting back on its asset purchases. Atlanta Fed President Dennis Lockhart said Tuesday he could see paring purchases later this year.
Bernanke and his closest allies at the U.S. central bank have strongly defended the Fed's continued accommodative policies, however, and it is unclear whether they are yet ready to change policy.
Williams, like Pianalto and Lockhart, does not have a vote this year on the Fed's policy-setting panel.
Williams -- who spoke in a downtown Los Angeles hotel ballroom in near darkness because of a local electricity blackout -- on Wednesday said he sees the economy growing at about 2.5 percent this year and 3.25 percent next year, helping to push unemployment down to a little below 7 percent by the end of next year.
Inflation, meanwhile, will stay well below the Fed's 2-percent goal, at about 1.5 percent this year and next, he predicted.
Fed policymakers have said both the low-rate vow and the asset-purchase program have begun to help the recovery gain some traction.
Williams echoed that view.
"The economy is on the mend, helped in part by the very stimulatory stance of monetary policy," he said, adding that he sees the benefits of the Fed's bond-buying program outweighing the costs "by a large margin."
The U.S. economy has generated an average of 200,000 jobs each month for the past four months. Unemployment registered 7.7 percent in February and economists expect it to stay there when the government releases March data this Friday.
But Williams said he needs even more solid evidence that the labor market is gaining traction before he can support a cutback in the Fed's asset-purchase program.
And even then, he does not expect employment to surge.
The U.S. central bank has vowed to keep rates low until unemployment falls to 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent.
Williams said he expects unemployment to reach that level by mid-2015, but not to fall to a more "normal" 5.5 percent level until 2016.
Williams stopped far short of advocating an increase in short-term rates that have been near zero for more than four years.
He took care to note that even if the Fed stops buying assets its $3 trillion portfolio of securities will continue to push long-term rates downwards.
And he emphasized that he does not support pulling back prematurely on Fed stimulus, a possibility against which Bernanke has warned.
"It is vital that we keep those extraordinary Fed measures in place for some time to make sure unemployment and inflation get back to healthy levels," he said.
Williams later added, in response to a question from the audience, that he is "completely convinced" the Fed has the tools to raise rates when needed.
Williams spoke without a microphone. Members of the audience signaled their desire to ask questions by waving greenish glowsticks in the dark room.