Federal Reserve officials again reiterated their commitment to low interest rates for an extended period on Thursday, given the fragile nature of the economic recovery, and suggested a reduction in the size of the central bank's balance sheet could take as long as two decades.
Echoing remarks on Wednesday by Fed chairman Bernanke, Fed vice chairman Donald Kohn on Thursday said a gradual U.S. economic recovery marked by high unemployment and tame inflation will require interest rates to remain very low for an extended period.
The Fed's promise to keep rates low is contingent though on economic conditions such as an absence of strong private demand and a reluctance by businesses to hire, Kohn indicated.
We cannot provide a precise timetable for when short-term interest rates will begin to return to normal because that depends on the evolution of actual and projected activity and inflation, Kohn said in a speech to a luncheon sponsored by the Federal Reserve Bank of San Francisco.
For now, Kohn said conditions do appear to warrant the central bank's highly accommodative stance, undertaken as a response to the worst financial crisis since the Great Depression.
In particular, Kohn focused on the labor market, which he characterized as extremely weak. Against that backdrop, Kohn believes inflation will not become a problem any time soon. He said the high jobless rate, which came in at 9.7 percent in March, suggested the economy was not operating anywhere near its maximum productive capacity.
In answer to a question, Kohn also said he did not think the U.S. government would have trouble finding buyers for its debt despite the nation's rising fiscal deficit.
Asked if he foresaw the possibility of a failed auction, where a given offering does not receive enough demand to meet the amount of bonds on offer, Kohn was emphatic.
No I don't, he said. The government of the U.S. stands behind its debt. That is unquestioned and will remain unquestioned. I am sure the auctions will continue to be covered.
On the question of whether the Fed would be willing to step in on the off chance that an auction were to fail, he said: I don't foresee any circumstance under which the open market committee would have to come in and cover an auction that didn't work.
In fact, we're kind of restricted from doing so under the law. We can't buy Treasury securities directly from the Treasury, we have to buy them in the open market, he said.
FED CAUTIOUS ABOUT SELLING ASSETS
Fed governor Daniel Tarullo also said on Thursday that U.S. monetary policy will probably need to stay unusually loose for some time because of a sluggish recovery marked by high unemployment and subdued inflation.
Tarullo also said he would be very cautious about selling assets from the central bank's $2.3 trillion balance sheet before a sustainable economic recovery is well established.
The relatively modest pace of recovery, the continued high rate of unemployment, subdued inflation trends, and well-anchored inflation expectations together suggest that the need for highly accommodative monetary policies will not diminish soon, Tarullo said in remarks prepared for delivery to a community bankers group.
His comments came two days after the central bank released minutes from its March policy-setting meeting in March which suggested that rates may stay ultra-low for even longer than investors expect if the economic outlook worsens or inflation drops.
As for community banks, Tarullo said they were still grappling with potential losses from commercial real estate loans, and that problem would likely be with us for some time to come.
The Fed and other banking agencies issued guidance last year on restructuring commercial real estate loans, and Tarullo said the hope was that this would help alleviate pressures on both the real estate market and small business lending.
FED ASSET SALES COULD TAKE TWO DECADES
Meanwhile, Narayana Kocherlakota, president of the Minneapolis Federal Reserve, said the Fed will likely need to sell a nontrivial amount of assets if it wants to return its balance sheet to normal within two decades, but will need to do so slowly or risk causing a jump in interest rates.
A monthly pace of $15 billion to $25 billion worth of sales in mortgage-backed securities over a five-year period would be slow enough to accomplish an exit from the mortgage business without rocking interest rates, he said.
The U.S. central bank trimmed its key short-term interest-rate target to near zero in December 2008 to help blunt the effects of a deepening recession.
It also bought more than $1 trillion of mortgage-backed securities issued by government-sponsored housing lenders, primarily Fannie Mae and Freddie Mac, in a bid to lower long-term interest rates and support the housing market.
Speaking in Helena, Montana, he said that while the U.S. economic recovery is underway, housing will take a long time to recover and the outlook for unemployment is not promising.
His prepared remarks were nearly identical to those delivered at the Minnesota Chamber of Commerce on April 6.
The economy is on the mend and should continue to recover over the next two years - in terms of both GDP and unemployment - but at slower rates than we would like, he told about 50 local business leaders gathered at a lunch at the regional bank's branch office in the Montana state capital.
Kocherlakota, who is not a voting member this year of the Fed's monetary policy-setting Federal Open Market Committee, repeated his forecast for 3.0 percent annual growth in the U.S. economy for the next two years, a more pessimistic view than many other economists.
Also on Thursday, Fed Chairman Ben Bernanke said the central bank's decisive response to the financial crisis prevented another Great Depression.
In remarks that were largely historical and skirted any direct references to the outlook for the economy or monetary policy, Bernanke emphasized the importance of a stable financial sector for solid economic growth.
In Dallas, Texas, on Wednesday, Bernanke had said the U.S. economy still faces significant headwinds, including a housing sector that has yet to recover convincingly and an ailing employment market.