December 8, 2008 / 9:01 AM / 11 years ago

Fed still has other tools to employ -Rosengren

NEW YORK, Dec 8 (Reuters) - The U.S. Federal Reserve is running out of room to cut interest rates further but it has other tools it can employ and fiscal policy could start to play a bigger role in spurring the recession-mired economy, a top Fed official said on Monday.

“Given that interest rates cannot be negative, further monetary-policy actions are limited by the zero lower bound for interest rates,” Boston Federal Reserve President Eric Rosengren said in remarks prepared for delivery to a conference in Geneva, Switzerland.

“While other monetary policy tools can be employed, increasingly many observers and commentators are suggesting that fiscal stimulus will be an important element of economic recovery,” he said.

Rosengren, who won’t assume a voting seat on the Fed’s policy-setting committee until 2010, also said the U.S. central bank’s emergency credit facilities have lessened the risk financing would not be available over year-end, although short-term credit markets remained strained.

“The improvement in what was a very large spread has been greatly aided by the various short-term credit facilities established by the Federal Reserve,” he said.

“The facilities have also reduced the risk that financing would not be available over the year end, as many commercial-paper issuers have now financed themselves beyond that point. But despite these improvements, short-term credit markets remained strained,” Rosengren said.

The Fed has rolled out a raft of unprecedented liquidity programs in its battle against the worst financial crisis in 80 years. They include facilities to restore lending by money market mutual funds and purchase short-term debt issued by companies. [ID:nN26350399]

The programs supplemented an aggressive interest-rate cutting cycle that has taken the benchmark federal funds rate down to 1.0 percent. Primary dealers polled by Reuters on Friday expect the Fed to cut interest rates to 0.5 percent or lower at its meeting this month. That would be the lowest on records dating to July 1954. [FED/R]

Rosengren said short-term credit markets and the housing market would have to recover before financial markets can return to normal.

“We need to see some improvement in the housing market before financial markets will resume a more normal state,” he said. “A number of proposals have been floated to help stem foreclosures but to date there has been relatively modest progress.”

He said the crisis provides a reason to reassess a regulatory framework that was ill-prepared for the types of liquidity shocks that have roiled markets.

“The current crisis provides the opportunity and impetus to re-examine a regulatory framework that originated in the Great Depression,” Rosengren said, adding that international cooperation was becoming more important.

“Future regulatory design must allow for innovation without increasing risk to the financial infrastructure and the real economy,” he said. “To the extent that more assets move to be exchange traded, counterparty risk is reduced and transparency is increased.”

He also said it was important to ensure public efforts to stabilize financial markets do not lead market participants to take excessive risks in the future.

“Ideally, situations requiring public support should occur only after losses have been borne by equity holders and existing management and directors have been held responsible for the losses.”

“In the U.S. the central bank can provide liquidity to the market place, but decisions to take on credit risk that pose substantial risk to the taxpayers should ideally be in the hands of the Treasury Department,” he said. (Reporting by Kristina Cooke)

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