February 12, 2013 / 9:36 PM / 5 years ago

WRAPUP 1-Subtle divergence in approach to Fed policy on display

NEW YORK/MADRID, Feb 12 (Reuters) - The subtle tug-of-war of U.S. monetary policy was on full display on Tuesday as one top Federal Reserve official said timidity could complicate the country’s already weak economic recovery, while another warned about the risks of being too bold.

Atlanta Fed President Dennis Lockhart, speaking in Madrid, predicted the U.S. economy would remain weak and cautioned that unemployment, at 7.9 percent last month, could become entrenched if left unaddressed.

“A sense of urgency is appropriate,” said Lockhart, a centrist who does not vote on Fed policy this year. “If policymakers are too patient, what started as cyclical problems can evolve into structural problems.”

While Lockhart’s view is in the majority of the U.S. central bank’s 19 policymakers, including that of Fed Chairman Ben Bernanke, there are also a handful of more hawkish voices who are less comfortable with the aggressive policies adopted to spur growth and hiring.

Kansas City Fed President Esther George, a voter who dissented at a Fed policy meeting last month, said the Fed could disrupt markets if it actively sells large amounts of mortgage-backed securities when the time comes to tighten monetary policy.

Addressing an audience at University of Nebraska-Omaha, George also warned that investors could question the central bank’s commitment to its 2-percent inflation goal if inflation expectations begin to rise.

When the time finally comes, “actively selling a large amount of agency mortgage backed securities ... could be potentially disruptive to markets and market functioning,” she said, adding: “These actions are untested.”

Both Lockhart and George largely repeated comments previously made on the Fed’s policies, which include near-zero interest rates likely over the next couple of years and $85 billion in monthly purchases of Treasury bonds and mortgage debt.

Bernanke has defended the Fed’s aggressive easy-money policies, arguing the economy needs to grow quicker to lower unemployment and withstand tighter fiscal policies and threats from abroad. He and others say the economy, especially interest rate-sensitive sectors like sales of homes and automobiles, has responded to monetary policy.

“While we’ve made progress, there’s still quite a ways to go before we’ll be satisfied,” Bernanke said in January.

Yet the slow overall recovery has cast some doubt on the U.S. central bank’s far-reaching strategy, with some, including some Fed officials and congressional Republicans, warning that the multi-trillion-dollar quantitative easing efforts risk future inflation and could crimp the Fed’s ability to tighten policy when the time it right.

The U.S. economy likely expanded only slightly in the fourth quarter, despite an early government estimate that Gross Domestic Product (GDP) unexpectedly fell at a 0.1 percent rate. As it stands, overall growth was just 2.2 percent in 2012, below the 3-percent pace to which the United States is accustomed.

In December, the Fed unveiled a so-called thresholds plan in which it pledged to keep interest rates ultra low until unemployment drops to 6.5 percent, from 7.9 percent last month, as long as inflation expectations remain below 2.5 percent.

In adopting these thresholds, the Fed has expressed some tolerance for having the inflation outlook exceed its 2-percent goal, George said on Tuesday.

That in turn “carries with it the risk that longer-term inflation expectations may flip above levels consistent with” the goal, and “cause the market to question the Federal Reserve’s commitment to its inflation goal,” she said.

Long-term inflation expectations usually predict actual inflation, George noted.

So far this year, U.S. inflation expectations have edged higher.

Nonetheless, Lockhart said he expects the Fed will need to continue its asset buying into the second half of this year in order to keep pressure on long-term interest rates, and encourage investment and hiring.

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