Senior U.S. Federal Reserve officials placed different emphasis on inflation risks on Thursday, with one warning failure to withdraw support policies soon enough could trigger inflation while another played down such risks.
Kansas City Federal Reserve Bank President Thomas Hoenig said the Fed should act sooner rather than later to contain longer-term inflation pressures and avoid sowing the seeds of a future crisis.
While there is considerable uncertainty about the outlook, the balance of evidence suggests that the recovery is gaining momentum. In these circumstances, I believe the process of returning policy to a more balanced weighing of short-run and longer-run economic and financial goals should occur sooner rather than later, Hoenig said.
In Shanghai, China, meanwhile, St. Louis Fed chief James Bullard said the U.S. jobless rate will start to fall soon and played down price pressures facing the United States in the near term, saying that the Fed's moves to pump liquidity into the economy were not an inflationary concern.
Both officials have votes on the Fed's interest-rate setting panel.
The Fed has chopped interest rates to near zero and pumped hundreds of billions of dollars into the financial system to gird the economy through the worst crisis since the Great Depression. The central bank has promised to hold rates exceptionally low for an extended period to steer the economy through what is forecast to be a sluggish recovery marked by persistently high joblessness.
The Fed's next interest-rate policy meeting is January 26-27. Most analysts do not expect the Fed to begin raising rates until the middle of the year at the earliest, and minutes of the Fed's December meeting showed a few officials suggesting it might be desirable to add or extend purchases if housing's or the economic outlook weaken.
Hoenig said the U.S. and world economies appear to be in the early stages of recovery, Hoenig, persistently one of the strongest voices of caution on inflation risks at the Fed, said that in the United States, labor market conditions have begun to stabilize and the housing market shows signs of recovery.
Uncertainty remains, however, with the unemployment rate unacceptably high, he said, acknowledging that short-term inflation risks are likely small.
However, he renewed his warning that keeping rates ultra-low for a long time is risky.
Maintaining excessively low interest rates for a lengthy period runs the risk of creating new kinds of asset misallocations, more volatile and higher long-run inflation, and more unemployment -- not today, perhaps, but in the medium
and longer run, Hoenig said.
Hoenig also argued that keeping short-term interest rates near zero could actually hurt the recovery process in financial markets.
With a low federal funds rate and a small spread between the discount rate and the rate paid on excess reserves, banks are more inclined to transact with the Fed instead of with each other. That prevents the interbank markets from working effectively, Hoenig said. Low rates also distort longer-term saving and investment decisions, he added.
At the beginning of the financial crisis in mid-2007, one of the first steps the Fed took was to narrow the gap between the discount rate -- the Fed's emergency lending rate -- and the fed funds rate, the rate banks charge one another for overnight loans.
Widening that spread again is one step the Fed could take as part of a broader move to tightening financial conditions in a healing economy.
Bullard warned that the Fed's extensive purchases of securities could fuel inflation over the medium term, although he also advocated continuing to purchase assets at a low level beyond a planned end of the program in March.
The St. Louis Fed chief said that the Fed would gradually wind down its MBS buying as it did with its purchases of Treasuries, and so the withdrawal should have little negative impact on the housing market.
If everything goes according to plan, I think the same will happen at the end, that it will be seamless, he said.
(Additional reporting by Jason Subler in Shangai; Editing by Kenneth Barry)