MINNEAPOLIS (Reuters) - Whoever takes over next year as chair of the U.S. central bank must show the world the Federal Reserve will do “whatever it takes” to boost employment and resist the inevitable calls to pare stimulus, a top Fed official said on Friday.
Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank, told Reuters that the U.S. central bank should only slow its $85 billion-a-month bond-buying program if it loses effectiveness, or if a smaller program would work better.
“I have to say I haven’t seen any evidence like that,” he said in an interview in the board room of the Minneapolis Fed.
Reducing the program for any other reason would send a message that the Fed is comfortable with, or powerless to change, the slow decline in unemployment, he said.
“That doesn’t make sense,” he said. “It’s not just a question of what we do, it’s why, it’s how you explain why you do it that really matters.”
The absence of a “comprehensive” strategy that captures the Fed’s longer-term policy intentions led to abrupt market reactions like the one last week after the Fed did not pare its bond-buying program as expected, he said.
Making clear that the Fed’s main aim is to quickly bring down unemployment - rather than setting separate benchmarks for bond-buying and interest rates - would provide “a lot of power” because it would signal policy would remain accommodative even if inflation exceeded 2 percent, he said.
Currently the Fed is using a two-pronged approach to lower borrowing costs: buying large amounts of long term assets and keeping short-term interest rates near zero.
It has promised to keep buying bonds until the labor market outlook improves substantially, and has carved out separate thresholds for when it will consider raising short-term rates.
Fed Chairman Ben Bernanke’s term ends in January and many say the biggest job for whoever succeeds him will be how to unwind the stimulus that has swollen the Fed’s balance sheet to $3.6 trillion over the course of nearly five years.
“I don’t think that’s the main job for the next chairperson,” said Kocherlakota, regarded as a policy dove.
“The main job is going to be to keep accommodation in place for the next few years, even though there is going to be lots of hue and cry to stop providing that accommodation. We already hear that hue and cry. That person is going to have to lead the committee to be strong against those kinds of criticisms.”
“WHATEVER IT TAKES”
Global stock markets shot higher after the Fed left its bond-buying program untouched at $85 billion per month, despite widespread bets the pace would be reduced. Some observers said the communication breakdown hurt the Fed’s credibility.
Beyond the bond-buying, the Fed has also said it will keep interest rates near zero at least until unemployment falls to 6.5 percent, from 7.3 percent last month.
“What’s going to happen at 6.5 percent? What will happen then to interest rates?” Kocherlakota said.
“If you articulate that you will do whatever it takes to get unemployment down, now we know we’re going to be keeping interest rates low at that point,” he said, unconsciously echoing a 2012 promise by European Central Bank chief Mario Draghi to go all-out to support the euro zone recovery.
Fed Vice Chair Janet Yellen, tipped as Bernanke’s successor, has advocated keeping policy very easy to reduce unemployment more quickly, even at the cost of a little inflation.
But other Fed officials have warned that continuing to buy bonds at $85 billion a month and keeping short-term rates near zero could spark future price pressure or lead to asset bubbles.
Indeed, several have said September 18’s shock decision to stand pat on policy was a close call.
Kocherlakota, who regains a vote on the Fed’s policy-setting committee next year, said the risks from continued stimulus are small, while the risks of pulling back too early are evident in the big market swings as investors try to second-guess the Fed.
Any increase in inflation due to the Fed’s super-easy policies is likely to be temporary and the Fed’s track record in forecasting inflation makes him confident that the central bank can head off any overheating of the economy.
“If our inflation outlook rises to 2.25 percent, or 2.5 percent as the committee has said, I think we can still pull back from the brink even if inflation were to get that high,” he said. The Fed’s policy-setting committee has said it will keep rates low to bring down unemployment as long as inflation does not threaten to breach 2.5 percent.
Writing by Jonathan Spicer and Ann Saphir; Editing by Chizu Nomiyama and Krista Hughes