By Alister Bull
CLAYTON, Mo, Feb 5 (Reuters) - The Federal Reserve must tackle the threat of deflation by aggressively expanding its balance sheet, but it is too soon to start buying long-dated U.S. Treasuries, a top Fed official said on Thursday.
The Fed has lowered interest rates almost to zero and pumped hundreds of billions of dollars into financial markets to prevent them freezing in panic over bank losses from the collapse of U.S house prices and a year-long recession.
Policy-makers voted last week to use all available tools to ease credit market conditions, including supporting the market for consumer and small business loans, as well as considering purchases of long-dated Treasury securities.
'I do think there are some downside risks on inflation, so you could end up in negative territory. I am worried about it, partly because of the global nature of this recession,' St. Louis Federal Reserve President James Bullard told reporters.
'I don't think we're going to get any good news into the fall of this year. So I think it is going to continue to put downward pressure on prices during that whole period ... I think policies have to be designed to avoid that outcome,' he said after delivering a speech to the CFA Society of St Louis.
Bullard said this policy should not be implemented until the Fed had a chance to see how its other actions were working, and how action planned by President Barack Obama takes shape.
'We're studying it (Treasury purchases) ... we have this MBS (mortgage backed securities) purchase program right now, so let's get an assessment of how that is working and then look at things going forward.
'Also, you have got the new administration just coming in and I think we want to get a handle on how they are going to proceed ... before we start making additional moves,' he said.
The Fed has launched a program to buy up to $500 billion of MBS in addition to supporting the market for top-rated issuers of commercial paper and providing a liquidity backstop to money market mutual funds. These unconventional monetary policy measures have helped to more than double the size of its balance sheet to around $2 trillion.
Fed action to boost liquidity is aimed at preventing a severe recession from turning into a prolonged slump. The Fed, with interest rates about as low as they can go, hopes credit easing will make it more attractive for Americans to borrow and spend, which in turn will stimulate the economy.
Bullard said this major increase in the balance sheet could fuel inflation in the future, depending on how much of the increase was persistent, or short-lived.
He said liquidity provisions to banks through programs like the Fed's Term Auction Facility could wind down relatively quickly. But measures to prop up mortgage-backed securities might be longer lasting.
This possibility was echoed by Minneapolis Fed President Gary Stern. Neither men are voters on the Fed's policy-setting committee this year.
'It ... remains unclear if further steps will be required to restore stability,' Stern said on Thursday. 'However, I am guardedly optimistic that many pieces are now in place to rebuild liquidity and to contribute to improvement in business activity.'
He told the Capital City Partnership Annual Meeting in St. Paul, Minn., that concerns about inflation resulting from the Fed's massive injections of liquidity cannot be dismissed, and neither can the risks of a deflationary spiral.
However, because of the long lag between growth in money supply and the path of prices, the Fed should be able to pull back in time to extinguish any flare-up in prices, Stern said.
'There is ample time to withdraw excess liquidity as appropriate, and in this regard the Federal Reserve remains firmly committed to long-run price stability,' he said.
Bullard said the U.S. economy's weakness in the fourth quarter was likely understated a bit in a government report that showed the economy shrank at a 3.8 percent annual rate.
He said the weakness was carrying over into the first quarter and that the second quarter would 'probably still (be) negative.' But later told reporters he expects growth to turn positive in the third quarter of this year.
(Additional reporting by Tim Ahmann and Glenn Somerville in Washington, Editing by Dan Grebler) Keywords: USA FED (E-mail: alister.bull@thomsonreuters.com) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.
CLAYTON, Mo, Feb 5 (Reuters) - The Federal Reserve must tackle the threat of deflation by aggressively expanding its balance sheet, but it is too soon to start buying long-dated U.S. Treasuries, a top Fed official said on Thursday.
The Fed has lowered interest rates almost to zero and pumped hundreds of billions of dollars into financial markets to prevent them freezing in panic over bank losses from the collapse of U.S house prices and a year-long recession.
Policy-makers voted last week to use all available tools to ease credit market conditions, including supporting the market for consumer and small business loans, as well as considering purchases of long-dated Treasury securities.
'I do think there are some downside risks on inflation, so you could end up in negative territory. I am worried about it, partly because of the global nature of this recession,' St. Louis Federal Reserve President James Bullard told reporters.
'I don't think we're going to get any good news into the fall of this year. So I think it is going to continue to put downward pressure on prices during that whole period ... I think policies have to be designed to avoid that outcome,' he said after delivering a speech to the CFA Society of St Louis.
Bullard said this policy should not be implemented until the Fed had a chance to see how its other actions were working, and how action planned by President Barack Obama takes shape.
'We're studying it (Treasury purchases) ... we have this MBS (mortgage backed securities) purchase program right now, so let's get an assessment of how that is working and then look at things going forward.
'Also, you have got the new administration just coming in and I think we want to get a handle on how they are going to proceed ... before we start making additional moves,' he said.
The Fed has launched a program to buy up to $500 billion of MBS in addition to supporting the market for top-rated issuers of commercial paper and providing a liquidity backstop to money market mutual funds. These unconventional monetary policy measures have helped to more than double the size of its balance sheet to around $2 trillion.
Fed action to boost liquidity is aimed at preventing a severe recession from turning into a prolonged slump. The Fed, with interest rates about as low as they can go, hopes credit easing will make it more attractive for Americans to borrow and spend, which in turn will stimulate the economy.
Bullard said this major increase in the balance sheet could fuel inflation in the future, depending on how much of the increase was persistent, or short-lived.
He said liquidity provisions to banks through programs like the Fed's Term Auction Facility could wind down relatively quickly. But measures to prop up mortgage-backed securities might be longer lasting.
This possibility was echoed by Minneapolis Fed President Gary Stern. Neither men are voters on the Fed's policy-setting committee this year.
'It ... remains unclear if further steps will be required to restore stability,' Stern said on Thursday. 'However, I am guardedly optimistic that many pieces are now in place to rebuild liquidity and to contribute to improvement in business activity.'
He told the Capital City Partnership Annual Meeting in St. Paul, Minn., that concerns about inflation resulting from the Fed's massive injections of liquidity cannot be dismissed, and neither can the risks of a deflationary spiral.
However, because of the long lag between growth in money supply and the path of prices, the Fed should be able to pull back in time to extinguish any flare-up in prices, Stern said.
'There is ample time to withdraw excess liquidity as appropriate, and in this regard the Federal Reserve remains firmly committed to long-run price stability,' he said.
Bullard said the U.S. economy's weakness in the fourth quarter was likely understated a bit in a government report that showed the economy shrank at a 3.8 percent annual rate.
He said the weakness was carrying over into the first quarter and that the second quarter would 'probably still (be) negative.' But later told reporters he expects growth to turn positive in the third quarter of this year.
(Additional reporting by Tim Ahmann and Glenn Somerville in Washington, Editing by Dan Grebler) Keywords: USA FED (E-mail: alister.bull@thomsonreuters.com) COPYRIGHT Copyright Thomson Reuters 2009. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.