Fed activism harms US growth prospects

Washington:  The US Federal Reserve's latest efforts to bolster the recovery with unprecedented policy tools will hurt the US economy in the long run, a former member of Fed Chairman Ben Bernanke's inner circle suggested on Thursday.

In his first public comments since stepping down as a Fed governor last March, Kevin Warsh said there is a place for exceptionally accommodative monetary policy to provide "important transitional support for an economy."

"But recent policy activism — measures that go beyond a central bank's capacity or traditional remit — threatens to forestall recovery and harms long-term growth," Warsh told the Stanford Institute for Economic Policy Research.

Warsh was the only member of Bernanke's inner circle with close ties to Republican lawmakers. An inflation hawk, Warsh nevertheless voted in favour of the Fed's groundbreaking moves to ease monetary policy after the financial crisis, including two bond-buying actions that swelled the Fed's balance sheet to unprecedented levels.

But Warsh apparently grew increasingly uncomfortable with the dovish stance of the central bank. Shortly after the Fed launched its second round of quantitative easing, in November 2010, Warsh publicly expressed doubt over its effectiveness.

He announced his resignation the following February, and is currently a visiting fellow at Stanford's Hoover Institution.

Since Warsh's departure, the Fed has embarked on still more easing, signaling last August its intent to keep rates ultra-low through at least mid-2013. On Thursday it extended that low-rate vow through late 2014.

The Fed also began publishing forecasts for short-term interest rates and adopted an explicit inflation target for the first time, setting its goal at 2 per cent. Bernanke said both moves would clarify the Fed's decisions, making them more effective.

Bernanke also opened the door wide to a third round of quantitative easing, saying continued low inflation and high unemployment would create a case for it.

In remarks more candid than any he made during his tenure at the Fed — "Now that I'm out of government I can tell you what I really believe," he quipped — Warsh on Thursday argued against more bond purchases.

By artificially lowering long-term yields, he argued, bond purchases mask how financial participants really view the long-term costs of large U.S. deficits and debt, and keep fiscal policymakers from seeing the consequences of their decisions.

Super-easy monetary policy also tends to push investors into riskier assets, a trend that fueled the very boom that came before that last financial crisis, he said.

"I don't think reacquainting consumers and investors with old bad habits is the way to have a stronger economy five years from now," Warsh said.

FED MISTAKEN?

Warsh also suggested that the Fed's adoption of an explicit inflation target may signal a willingness to allow temporarily higher inflation in order to help bring down unemployment.

Chicago Fed President Charles Evans recently made the case for an inflation target for exactly that reason.

"If that's the path they are going down," Warsh said, "I think they are going to be sorely mistaken."

Neither Bernanke's latest communications push or his recent foray into housing policy were exempt from Warsh's criticism, delivered in genteel tones before an audience that included some of Warsh's former professors.

"Central bank transparency is good, but transparency that delineates future policy breeds market complacency," Warsh said.

Warsh also was critical of leaning on government-run mortgage finance firms to pull the country from its housing slump, a policy idea the Fed floated in early January in an unsolicited paper to top lawmakers outlining a number of ways to revive the sector.

The Fed noted that exposing the firms to losses could be worthwhile if such actions could spur a vigorous recovery in housing, the bane of the current sluggish recovery.

Warsh disagreed.

"The government-sponsored housing entities remain sources of vulnerability to the U.S. economy, and repeated ad-hoc attempts to push Fannie Mae and Freddie Mac to take greater risks at taxpayer expense is deeply counterproductive," Warsh said.