St. LOUIS (Reuters) - More Federal Reserve bond purchases could fuel inflation risks even though they would be a forceful measure to spur growth, a top Fed policy maker said on Tuesday.
“While outright asset purchases are a potent monetary policy tool ... they must be used carefully because increases in the size of the balance sheet entail additional inflationary risks,” St. Louis Fed President James Bullard said in comments prepared for delivery.
The Fed cut interest rates to near zero almost three years ago and has continued to ease financial conditions by buying $2.3 trillion in bonds. In so doing, it has more than tripled the size of its balance sheet from pre-crisis levels.
As sluggish growth fails to quickly lower the lofty unemployment rate, Fed officials are battling over whether to take further steps to speed up economic activity.
Bullard said that if further monetary policy accommodation should be necessary, the Fed should use the tool of promising not to raise rates until a specific date. It has already pledged to keep rates exceptionally low until mid-2013.
However, while such a communications approach may be effective, it is not clear how credible such commitments are, Bullard said. For example, the Fed may be under pressure to raise rates if recovery accelerates.
“If the economy is actually performing quite well at the point in the future where the promise begins to bite, then the committee may simply abandon the promise and return to normal policy,” he said.
Bullard is not a voter on the Fed’s policy-setting panel this year.
Tying policy decisions to a specific unemployment rate, as policymakers have discussed, would be “unwise,” he added.
“Unemployment rates have a checkered history in advanced economies,” he said. “Monetary policy could be pulled off course for a generation.”
Bullard said that while financial turmoil in Europe poses risks to the U.S. economy, European woes are too distant to currently put much of a dent in U.S. consumer confidence.
If the situation in Europe worsens, the Fed could reopen some of the liquidity facilities it established at the height of the financial crisis in 2008-2009.
The United States has weathered a recession scare that peaked in the summer and data point to continued modest growth, he said.
Reporting by Mark Felsenthal; Editing by James Dalgleish