Fed’s Bullard says extended period vow bears risks

STOCKHOLM, May 27 (BestGrowthStock) – A Federal Reserve policymaker
warned that the central bank’s vow to keep rates unusually low
for a long time could, if misread, perpetuate the boom and bust
cycle that plunged the United States and the world into
recession.

“Markets may confuse the policy with the ‘interest rate
peg’ policy, in which rates do not adjust in response to
shocks,” St. Louis Federal Reserve Bank President James Bullard
said in remarks prepared for delivery to a conference in
Stockholm.

“In particular, multiple equilibria or ‘bubbles’ are
possible,” he said at the event, which is sponsored by Swedish
bank Swedbank.

Despite noting risks associated with the extended period
promise, Bullard has backed the Fed’s decision to renew that
pledge at its April meeting.

On Thursday, Bullard noted the policy can be successful at
providing additional stimulus to an economy when borrowing
costs are near zero, as they have been in the United States.

Since the April meeting, evidence the U.S. economic
recovery is accelerating has piled up, although it has been
tempered by worries Europe’s sovereign debt crisis could
deliver a shock to financial markets.

On Wednesday, reports said new U.S. home sales reached a
two-year high and durable goods orders surged in April.

Most of the financial firms that deal directly with the Fed
do not expect it to begin raising rates until 2011, a Reuters
poll conducted on May 10 showed.

The U.S. central bank cut rates to the bone in December
2008 and then flooded the financial system with hundreds of
billions of dollars to pull the economy out of the worst crisis
since the Great Depression.

Bullard, a voter on the Fed’s policy setting panel, is not
viewed as among the most stringent inflation hawks among
policymakers.

However, he has emerged as a vocal advocate for quickly
shrinking the Fed’s extensive quantitative easing efforts by
selling off some of the mortgage-related debt the central bank
has bought.

Flooding financial markets with bank reserves to induce
economic growth, as the Fed’s asset purchases did, can cause
inflation if markets lose faith in a central bank’s commitment
to drain reserves in a timely manner, he said in Stockholm.

The consensus view at the Fed, reflected in comments by Fed
Chairman Ben Bernanke, is that its bloated balance sheet will
shrink naturally as the assets mature or are paid off.

Bernanke has said that sales of assets are only likely
after the Fed begins to raise interest rates in a clearly
recovering economy and if policymakers want to speed up their
withdrawal of stimulus.

However, most Fed policymakers now agree that it will be
advisable to sell some off some of the approximately $1.4
trillion in mortgage-related debt the Fed bought. That is
because they believe there is a risk of inflation from too big
a balance sheet and because they dislike providing help for a
specific sector, housing, as they do by holding so much
mortgage debt.

Bullard was among three Fed officials who sought an
increase in the Fed’s emergency lending rate, known as the
discount rate in April.

The discount rate is the rate the Fed charges for banks to
borrow and is different from the interbank lending rate, or Fed
funds rate, that it targets to steer the economy.

Growing sentiment in favour of raising the discount rate
primarily signals comfort that the financial industry is
stabilising after the 2007-2009 financial crisis but could be
an early indicator of rising support for dropping the extended
period language.

Stock Market Money
(Reporting by Mark Felsenthal; Editing by Jan Dahinten)

Fed’s Bullard says extended period vow bears risks