May 6, 2010 / 5:01 PM / 9 years ago

WRAPUP 1-European debt woes could hurt US, Fed says

* Potential debt default a risk to US outlook - Bullard

* Euro zone woes could have noticeable effects - Lacker

* US govt needs to address its debt problems - Hoenig

By Pedro Nicolaci da Costa

RICHMOND Va., May 6 (Reuters) The U.S. Federal Reserve is closely monitoring financial turbulence in Europe as it could have repercussions for the United States and its markets, policymakers at the central bank said on Thursday.

James Bullard, president of the St. Louis Fed, argued the European crisis, which centers on worries about the high debt level of Greece and other member states, poses a threat to an otherwise improving U.S. economic outlook.

“One risk to the outlook ... is the fallout from potential sovereign debt default as conditions continue to deteriorate in Greece and other countries,” Bullard told an audience at Washington University’s Olin Business School.

His counterpart at the Richmond Fed, President Jeffrey Lacker, said the ongoing turmoil, which has led to deadly protests in Greece, was not affecting his outlook for the U.S. economy thus far, though it bears watching.

“They are something we’re paying close attention to. It has the potential to develop into something that has noticeable effects. But I don’t see that so far,” he told reporters after a speech in Richmond.

The euro and world stocks have fallen over the last three days over worries Greece’s debt crisis was spreading to other weak euro zone economies. Greece is preparing to adopt harsh austerity measures as part of a European rescue package aimed at staving off a sovereign debt default.

Bullard raised the possibility of a debt restructuring, saying other countries have been through such restructurings before.

“Restructuring debt, if it does come to that, you can live through it ... it’s not pleasant,” he said. “It does create a lot of volatility.”

Strain in money markets reminiscent of those seen in the early stages of the global financial crisis, back in mid-2007, resurfaced this week on fears the euro zone crisis could choke interbank lending.

Despite the difficult picture, the European Central Bank on Thursday stopped short of taking extra measures to stop the crisis spreading and left interest rates unchanged. Speculation was growing it might have to take new steps to contain sovereign debt problems.

Thomas Hoenig, president of the Kansas City Fed, said the U.S. government should not neglect to address its own indebtedness, which he said could increase pressure on the central bank to keep rates low to “monetize” deficits.

Hoenig and Lacker, considered among the more hawkish members of the Fed, argued that the central bank should strive to “normalize” its balance sheet by selling some of the mortgage-backed debt acquired during the financial crisis.

In response to the most severe financial crisis since the Great Depression, the Fed not only cut interest rates effectively to zero but also purchased over $1.4 trillion in mortgage-backed securities.

“It makes begin normalizing our balance sheet in advance of raising rates,” Lacker told the Virginia International Investors Forum. “Normalizing our balance sheet means reducing its size, (and) also returning to our traditional Treasury-only asset holdings.”

Lacker said he is still supportive of the central bank’s vow to keep rates low for an “extended period” as of today, but added he is always reassessing its usefulness.

“Today, I am still comfortable with I. But I continually reevaluate it,” he said.

Fed Chairman Ben Bernanke also spoke on Thursday, but did not directly address the outlook for monetary policy. Rather, he focused on the Fed’s efforts to reform its approach to supervision, saying the central bank may publish more supervisory information publicly given what he called the success of last year’s bank stress tests.

Additional reporting by Mark Felsenthal in St. Louis and Ann Saphir in Chicago; Editing by Andrew Hay

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