The Federal Reserve is undertaking a dangerous gamble by keeping rates at near zero for so long, and it must start raising rates or risk damaging the nascent U.S. recovery, a top Federal Reserve official said on Friday.
To be clear, I am not advocating a tight monetary policy, Kansas City Reserve Bank President Thomas Hoenig told a town hall meeting organized by the Lincoln, Nebraska, Chamber of Commerce and U.S. Representative Jeff Fortenberry.
I am advocating a policy that remains accommodative but slowly firms as the economy itself expands and moves toward more balance.
Hoenig has been the lone dissenter on the Fed's policy-setting panel, which on Tuesday repeated the U.S. central bank's pledge to keep interest rates extraordinarily low for an extended period.
The Fed also said it would begin reinvesting cash from maturing mortgage bonds to buy more government debt. The decision reflected its concern over the slowdown in the economic recovery it helped bring about by cutting rates to near zero in December 2008 and buying nearly $1.3 trillion in mortgage-linked debt to shore up the housing market.
However, Hoenig said on Friday he believes the economy barring specific shocks and bad policy ... should continue to grow over the next several quarters.
NO FAN OF ZERO
The Fed should raise its short-term target to 1 percent, pause to wait for the economy to adjust, and then raise it to 2 percent once it is clear the recovery is on a reasonable growth path, he said, repeating a proposal he has made before.
I believe that zero rates during a period of modest growth are a dangerous gamble, Hoenig said on Friday.
Stephen Stanley, chief economist at Pierpont Securities, said in a note to clients, in reference to Hoenig's speech:
In the era of inflammatory bloggers, talk radio, and 24-hour news opinion, I realize this might seem tame at first glance, but remember that this is a member of the FOMC absolutely ripping his own Committee's policies.
Hoenig said the United States is expanding at a faster pace than in two previous economic recoveries, corporate profits are up, and certain parts of the economy, like investments in software and other aspects of high tech, are growing at double-digit rates.
Though Fed officials have said they will tighten monetary policy again when conditions merit, such promises usually aren't kept, Hoenig added.
There is always always a strong commitment, when you are putting money into the system ... that when the time is right, you pull it out, he said. Well, we never do. We wait ... because you never know if the economy is strong enough to pull it out.
He said it was dangerous now to keep in place a policy meant to provide an emergency jolt to an economy in freefall.
The issue is not that we don't have enough money and liquidity in the system. The issue is, we don't have enough confidence to lend and borrow, he said.
Confidence will return as the economy improves, he said.
This week, Hoenig dissented for a fifth straight meeting from the vow to keep rates low, and said he believed the economy did not need further help.
We need to get off of the emergency rate of zero, move rates up slowly and deliberately, he said. This will align more closely with the economy's slow, deliberate recovery so that policy does not lag the recovery.
DEPARTING FROM THE FED'S NORM
U.S. central bank policies weren't the only targets of Hoenig's criticism. Hoenig also expressed doubt that international and domestic policies designed to prevent another financial crisis would be effective.
Internationally, the Basel Committee, which is working on new global banking standards, has agreed to establish capital-to-asset ratios for the largest global banks at levels that leave too small a margin for error, he said.
It is a level of risk that I judge unacceptable, he said.
And Hoenig added that recent Wall Street reform in the U.S. to tighten financial regulation would only be successful to the extent that authorities implemented the new law well.
U.S. officials have said their next target for reform are the giant mortgage lenders Fannie Mae and Freddie Mac, which were seized by the government at the height of the 2008 financial crisis because they were in danger of failing.
Hoenig said he did not think the lenders should be reprivatized, but should stay under government control.
Stanley of Pierpont Securities summed up his reaction to Hoenig's stunning speech in his note to clients:
I have to say that I have never, in nearly 20 years of watching the Fed, seen a speech quite like this from a member of the FOMC. Within the constraints of how Federal Reserve officials operate, I would call this a scathing critique of monetary policy now and over the last 10 years.