July 1, 2011 / 1:03 AM / in 8 years

WRAPUP 3-Fed should act if recovery disappoints -Bullard

* Higher inflation than in 2010 makes situation different

* QE as effective as conventional policy

(Recasts with views on further easing)

By Mark Felsenthal

ST. LOUIS, June 30 (Reuters) - The U.S. Federal Reserve should be prepared to act to support the economic recovery again if growth disappoints, a top official said on Thursday, the day the central bank’s latest bond buying round ended.

“If the economy’s not performing well, then the committee should consider taking additional action,” St. Louis Fed President James Bullard told reporters on the sidelines of a conference at the St. Louis Fed.

Bullard said he expects sluggish growth to pick up in the second half of the year as the drag from the effects of Japan’s tsunami and higher global oil prices diminishes.

The Fed needs to pause after the end of its latest bond-buying program and assess the direction of the economy for a while before deciding on any further steps, he added.

He also cautioned that inflation, which has jumped higher in recent months on rising energy and food costs, limits the Fed’s options.

“The situation today is very different than last summer, especially on the inflation side,” he added. A year ago, inflation was heading toward record low levels. It has risen sharply in recent months.

Bullard is not a voting member of the Fed’s policy-setting Federal Open Market Committee this year and is viewed as a centrist among Fed policy makers. His remarks suggest that if the central bank decides the recovery needs another jolt, at least one official would view more bond buying as an effective tool.

The Fed has signaled it is not immediately planning to renew bond purchases, although it has pledged to reinvest maturing securities to prevent its balance sheet from shrinking. Fed Chairman Ben Bernanke struck a similar tone to Bullard last week, saying that while the recovery is still weak, rising inflation means economic conditions are different than those that led the Fed to launch the initiative last November.

However, with growth in the second quarter expected to be unimpressive after clocking an anemic 1.8 percent annualized rate in the first quarter, and with unemployment at an elevated 9.1 percent, the Fed may eventually feel under pressure to act.

ACTIONS LOUDER THAN WORDS

Bullard made clear he believes large-scale bond buying can be an effective monetary policy substitute when the Federal Reserve runs out of room to cut interest rates.

He pronounced the purchases, which have totaled $2.3 trillion in all, successful in easing financial conditions.

“This experience shows that monetary policy can be eased aggressively even when the policy rate is near zero,” he said at the conference, which evaluated quantitative easing.

Bullard qualified his assessment by saying the effects of bond buying on reviving the economy are harder to gauge and have been clouded by shocks, such as Japan’s disaster and financial turmoil surrounding European debt problems.

However, he also said bond-buying is a more effective tool than trying to bolster the Fed’s promise to keep benchmark short term rates exceptionally low for an extended period. Bernanke has said that enhanced guarantees of low interest rates are among tools still available to policymakers.

The Federal Reserve exhausted its conventional tools when it cut short-term interest rates to near zero in December 2008.

Since then the Fed has sought to provide an additional boost to the economy via two asset-buying programs — with the second program dubbed QE2 — effectively showering the banking system with money to try to spur lending. Economists call this tactic quantitative easing.

One Fed official who is not likely to support more bond buying is the president of the Kansas City Fed, Thomas Hoenig, who said on Thursday that keeping interest rates near zero for an extended period is sowing the seeds of future economic instability. For details, see [ID:nN1E75T1JA]

An anti-inflation hawk who had opposed the Fed’s second round of quantitative easing, Hoenig reiterated his concerns that ultra-low rates can generate bubbles elsewhere.

“An extended zero-interest rate policy is producing new sources of fragility that we need to be aware of,” he told the Rotary Club of Des Moines, Iowa.

ECONOMIC IMPACT OF QE2 IS DELAYED

Many academics agree that quantitative easing has, in fact, been an effective monetary policy tool when interest rates are near zero, lowering interest rates on longer-term securities and steering investors to take on risker assets.

The Fed’s bond-buying program, however, has drawn sharp criticism from many for risking inflation and contributing to rises in food and energy costs around the world. Others have questioned its effectiveness.

Bullard said on Thursday that while the bond-buying program impacted financial markets immediately, its effect on the broad economy will lag by as much as a year.

“The effects of QE2 would be expected to lag by six to 12 months,” Bullard said.

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