February 28, 2014 / 3:15 PM / 6 years ago

Fed's Kocherlakota: policy must heed financial stability risks

Feb 28 (Reuters) - A top Federal Reserve official known for his dovish views on policy acknowledged on Friday that monetary policymakers may need to take financial stability risks into account when making policy choices.

But Minneapolis Fed President Narayana Kocherlakota, who has repeatedly called on the U.S. central bank to ease policy further, stopped short of saying that such risks should keep the Fed from doing whatever it can to return the economy more quickly to full employment.

While easy monetary policy can set the stage for a future sudden rise in rates that can impede the economy, it is difficult to gauge that risk accurately, he said in slides prepared for a presentation to a conference hosted by the University of Chicago’s Booth School of Business in New York.

His talk was a response to a paper by several respected economists that argued the market turbulence of last year’s “taper tantrum” is likely to stage a repeat performance when the Fed decides to boost interest rates.

In his prepared slides, Kocherlakota offered a framework for assessing the degree to which a rapid rise in market rates might hurt economic growth or cause a financial crisis. However, he did not draw any firm conclusions about how that framework should impact current monetary policy.

Kocherlakota, who has a vote on the Fed’s policy committee this year, has repeatedly said that high unemployment and low inflation should make the Fed ease policy even further than it already has, possibly by promising to keep rates low even longer than it already does.

Bond yields surged last year after Fed Chairman Ben Bernanke signaled the Fed’s bond-buying program known as QE3 would be wound down.

Arguably, the “large increase in yields only happened because monetary policy (QE3) had lowered yields so much,” Kocherlakota said.

The key question, he said, is whether that sudden rise in yields hurt overall economic growth more than the earlier decline in yields had helped.

The answer, he said, is far from clear.

“There is considerable need for new theory and empirics,” he concluded.

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