Fed's Yellen: Possible that low rates feed bubbles

DENVER (Reuters) - Low interest rates can contribute to financial bubbles even if they are not a primary culprit, Janet Yellen said in her first speech as vice chair of the Federal Reserve.

Janet L. Yellen, president and chief operating officer of the Federal Reserve Bank of San Francisco, speaks at the Town Hall Los Angeles forum in Los Angeles March 23, 2010. REUTERS/Mario Anzuoni

At a time of growing concern about the international repercussions of another possible round of monetary easing by the U.S. central bank, Yellen’s comments suggested Fed officials are cognizant of the risks to its zero rate policy.

“It is conceivable that accommodative monetary policy could provide tinder for a buildup of leverage and excessive risk-taking in the financial system,” Yellen said in prepared remarks to the National Association for Business Economics.

Countries from Latin America to Asia have complained rather loudly that the Fed’s push toward renewed monetary easing is unduly pushing up their currencies against the U.S. dollar, hurting their competitiveness.

Yellen, until recently the president of the San Francisco Fed and a strong dovish voice at the U.S. central bank, did not directly address the outlook for the economy or monetary policy. Nor did she imply that the threat of bubbles, which has underpinned a string of dissents on the Federal Open Market Committee by Kansas City Fed President Thomas Hoenig, would be enough to dissuade the Fed from easing further.

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Markets have all but priced in an expectation that the central bank will boost its purchase of Treasury bonds at its November meeting, an effort to prop up an ailing recovery that has left inflation at levels that some Fed officials consider dangerously low.

Employment, which along with price stability forms the central bank’s dual mandate, has also been a key driver of policy. The country’s jobless rate is currently hovering at 9.6 percent, and is expected to edge lower only slowly over the next few years.

Still, Yellen spent the bulk of her remarks reviewing the lessons for regulators from the financial crisis. One important thing to remember, she said, is that markets left to their own devices can cause tremendous instability.

“(Financial markets) were viewed as self-correcting systems that tended to return to a stable equilibrium before they could inflict widespread damage on the real economy,” she said.

“That view lies in tatters today as we look at the tens of million of unemployed and trillions of dollars of lost output and lost wealth around the world.