A top Federal Reserve official said on Thursday large-scale bond buying can be an effective monetary policy substitute when the central bank runs out of room to cut interest rates.
Speaking on the final day of the Fed's latest bond-buying initiative, St. Louis Federal Reserve President James Bullard 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 a St. Louis Fed conference evaluating quantitative easing.
Bullard qualified his assessment by saying the effects of bond buying on reviving the economy are harder to evaluate and have been clouded by shocks, including disruptions from the Japanese tsunami and European debt problems.
Responding to a financial crisis that brought markets to a standstill and plunged the world's largest economy into a severe recession, 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 by embarking on two programs of asset-buying, effectively showering the banking system with money to try to spur economic activity. Economists call this tactic quantitative easing.
Bullard is not an FOMC voter this year, and he is seen as a centrist on the spectrum of inflation-focused hawks and jobs and growth-centered doves on the Fed. His remarks suggest that if the central bank decides the recovery needs another jolt, at least one Fed 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 said last week that while the recovery is still weak, rising inflation means economic conditions are different than those that led the Fed to launch the initiative in November.
Nevertheless, with growth clocking an anemic 1.8 percent annualized rate in the first quarter, and with unemployment at 9.1 percent, the Fed may come under pressure to take further action.
One Fed official who is not likely to support more bond buying is Kansas City Fed President Thomas Hoenig, who said on Thursday keeping interest rates near zero for an extended period is sowing the seeds of future economic instability.
An anti-inflation hawk who opposed the $600 billion bond-buying stimulus that drew to a close on Thursday, 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, Hoenig told the Rotary Club of Des Moines, Iowa.
Still, he offered little evidence that such bubbles were forming, other than a reference to rising land values in Iowa.
Hoenig, who retires in October, said that while the U.S. recovery was frustratingly weak, monetary policy was not the right remedy.
Many academics, including several presenting papers at the conference sponsored by the St. Louis Fed, agree that quantitative easing has in fact been an effective monetary policy tool when interest rates are near zero.
The policy has lowered interest rates on longer-term securities and pushed many investors to take on riskier assets, economists at the conference said.
Fed asset purchases lowered the interest rate on the 10-year Treasury by between 30 basis points and 100 basis points, according to a paper whose authors included economists at the New York Fed. A basis point is one-one hundredth of a percentage point.
The Bank of England's Michael Joyce said at the conference that that central bank's quantitative easing program has lowered yields on British government securities by 100 basis points.
However, many others have harshly criticized the program 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 (the second round of quantitative easing) would be expected to lag by six to 12 months, Bullard said at a conference.