November 28, 2012 / 1:02 AM / 5 years ago

Evans: Fed should keep rates low until unemployment hits 6.5 percent

TORONTO (Reuters) - One of the U.S. central bank’s most outspoken policy doves on Tuesday called for the Federal Reserve to unleash even more monetary stimulus, saying interest rates should stay near zero until the jobless rate falls to at least 6.5 percent.

Such a policy would carry “only minimal inflation risks,” Charles Evans, president of the Chicago Federal Reserve Bank, said in remarks prepared for delivery to the C.D. Howe Institute in Toronto.

Rates could stay low providing the inflation outlook for the next two to three years remains below 2.5 percent, he said.

The proposal represents an important shift for Evans, who for the past year has called for low rates until the jobless rate falls to 7 percent, as long as inflation does not threaten to breach 3 percent.

On Tuesday Evans said he now views a 7 percent unemployment threshold as “too conservative.”

He also said he now believes that a 2.5 percent inflation safeguard is appropriate, given that a higher threshold “makes many people anxious,” and is not needed in order for the policy to work.

“We’re much more likely to reach the 6.5 percent unemployment threshold before inflation begins to approach even a modest number like 2.5 percent,” he said.

With the inflation outlook currently below the Fed’s 2 percent target, the U.S. central bank’s policymakers have been increasingly focused on ways to bring down the still-elevated unemployment rate, which registered 7.9 percent last month.

In September the Fed launched an open-ended asset-purchase program, kicking it off with a monthly $40 billion in mortgage-backed securities and promising to continue or ramp up the program unless the outlook for the labor market improves substantially.

Those purchases come on top of the $45 billion in long-term Treasuries the Fed is buying each month under Operation Twist, purchases that are funded with sales of a like amount of short-term Treasuries. Evans on Tuesday said he was among policymakers who want the Fed to step up its quantitative easing program to fill the gap after Twist expires in December.

“It’s important to maintain the overall level of asset purchases at $85 billion, at least for a time until we can see whether or not we are doing better or things are going more slowly, and we can adjust, depending on that assessment,” he told reporters.

“I think we have to have discussion about what is ‘substantial improvement.’ Have we seen it? In my opinion, we have not,” he told reporters.

He said he would judge the labor market as substantially improved once he sees monthly job gains of a least 200,000 for about six months, as well as above-trend growth in gross domestic product that would lead to declines in unemployment.

“I would be very surprised if we could achieve that before six months have passed, and I would not be surprised if it takes until the end of 2013,” he said.

In September, and again in October, the central bank said it would likely keep rates low until at least mid-2015, after the economy has strengthened. Keeping rates low for so long does not necessarily mean the Fed would tolerate higher inflation, Evans said.

Evans told reporters that he currently expects it to be 2015 before unemployment reaches 6.5 percent, and that he is “hard pressed” to see inflation much above 2.3 percent even with interest rates kept low until then.

The Fed’s 19 policymakers have been ramping up discussions on so-called thresholds - economic data points such as specific unemployment and inflation rates - that would signal when the central bank is likely to begin raising benchmark interest rates from near zero.

Evans on Tuesday said there was “vigorous” discussion on the issue at the Fed’s October meeting, and cited public support for the idea from Minneapolis Fed President Narayana Kocherlakota, Boston Fed President Eric Rosengren and the Fed’s influential vice chair, Janet Yellen.

Each policymaker wants slightly different thresholds. Rosengren has picked a jobless rate of 6.5 percent as his threshold, while Kocherlakota wants to keep rates low until unemployment reaches 5.5 percent, as long as inflation does not threaten to rise above 2.25 percent.

Fed Chairman Ben Bernanke has called the thresholds “a very promising direction” for policy because they would help markets predict future Fed decisions. But it would be a challenge to summarize into “two or three numbers” the conditions necessary for the Fed to tighten policy, he cautioned.

Writing by Ann Saphir; Editing by Leslie Adler

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