Fed's Warsh warns of false optimism on U.S. economy

NEW YORK (Reuters) - A top Federal Reserve official warned on Tuesday not to take recent gains across a range of asset prices as proof the U.S. economy is on the verge of a strong recovery.

A man stands with a sign advertising the last five days of a sale at the Virgin Megastore in New York's Union Square June 10, 2009. REUTERS/Shannon Stapleton

“The panic’s hasty retreat should not be confused with robust recovery,” Federal Reserve Governor Kevin Warsh said in prepared remarks to the Institute of International Bankers annual meeting in New York.

“The rather indiscriminate bounce off the bottom -- across virtually all assets and geographies -- may be more indicative of a one-time reset, which may or may not be complete.”

Warsh said private demand, the true arbiter of economic performance, “remains weak” even while government spending has surged, and the the jobless rate is likely to peak at a higher rate, and linger longer at those high rates, than in recent recessions.

“The ‘jobless recovery’ may prove to be a familiar and vexing refrain,” he said.

“I would expect business capital expenditures and consumer spending to continue to disappoint for the next several quarters,” Warsh added.

Rising exports will also not provide an easy way for the U.S. economy to return to growth, he said. “The global economy runs the risk of being mired in a period of slower growth for several years to come.”


Looking forward, the Fed “will not ... compromise price stability” by monetizing large U.S. budget deficits, he said, warning that higher interest rates were a risk.

“Financial markets may extract penalty pricing if fiscal authorities are unable to demonstrate a credible return to sustainable budgets,” the policy-maker said.

The Fed will be operating at a time when political pressures call for “still more-aggressive macroeconomic policies,” Warsh noted.

Warsh did not foresee the fast end to the recession that many economists now anticipate, but looked for the huge fiscal and monetary stimulus to finally kick in.

“On balance, I would not be surprised if these countervailing forces -- unprecedented public support and underwhelming private demand -- fight to a draw by the fourth quarter,” he said.


Warsh also warned of a trade-off between policies designed to create stability, especially after the tumult of the past couple of years, and the overall prospects for the U.S. economy.

“Stability is a fine goal. But it’s not a final one,” he said. “We must be wary of macroeconomic policies that -- in the name of stability -- may have the effect of lowering trend growth and employment rates.”

In particular, to the extent that changed policies reduce potential growth, or raise the natural rate of unemployment above the 5 percent rate assumed for many years, “it is more difficult to make good and timely policy,” said Warsh.

Editing by Neil Stempleman