Bullard Says Interest Rate Policy Assuming Economic Slack Risks Disaster

Federal Reserve Bank of St. Louis President James Bullard said holding interest rates near zero to counteract a high degree of slack in the U.S. economy may be a costly mistake.

“If we continue using this interpretation of events, it may be very difficult for the U.S. to ever move off of the zero lower bound on nominal interest rates,” Bullard said today in a speech in Chicago. “This could be a looming disaster for the United States.”

Better-than-forecast data on the economy such as the unemployment rate indicate that more Fed purchases of bonds, known as quantitative easing, aren’t necessary, Bullard told reporters after his speech. He was the first Fed official in 2010 to call for a second round of asset purchases.

Chairman Ben S. Bernanke said on Jan 25 the central bank might consider more purchases after the Federal Open Market Committee pledged to keep the benchmark interest rate at a record low at least until late 2014.

Such easing is a “potent weapon” to be held in reserve because it could raise inflationary pressures and complicate an eventual exit strategy from record easing, Bullard said. He doesn’t vote on monetary policy this year.

“The risks have to be weighed against the rewards,” he said. “We shouldn’t do any further QE unless we see deterioration in the economy and especially a threat of deflation that is rising considerably higher than it is today.”

Individual Forecasts

FOMC members at the meeting outlined their individual forecasts for an increase in the target interest rate. Bullard said he predicted the Fed will probably raise rates next year.

The St. Louis Fed chief said he would have dissented from an FOMC commitment to keep interest rates low until at least late 2014 because he opposes fixing a date for monetary policy.

“These things are guesses because there is a lot of uncertainty,” he told reporters. “We are into a game where we are going to have to change the date every so often as the economic situation changes, and I don’t think that is a good way to operate policy.”

An increase in the interest rate on excess reserves could be part of an eventual tightening, he said.

In the text of his remarks, Bullard told the Union League Club of Chicago that economists who believe economic performance is “stunningly far below where we should be” assume the economy should have grown at normal rates starting in late 2007 when the recession started. Yet growth was artificially boosted by the housing bubble, so there is little reason to expect growth to return to an artificially high trend, he said.

Decline in Prices

Instead, a decline in housing prices created a permanent loss of wealth, so there is no rationale based on economic slack alone to keep rates near zero, Bullard said.

A zero-rate policy by the central bank “punishes savers in the economy,” hurting “older Americans” in retirement and many young people can’t or don’t want to borrow at low rates because of a weak job market, he said.

Bullard endorsed the Fed’s adoption of a formal inflation target of 2 percent, which he said “will serve the nation well for years.”

Inflation has been “moderating in recent reports” and is “up sharply” from the second half of 2010, when the Fed began a second round of asset purchases, Bullard said.

The St. Louis Fed official’s comments followed last week’s report by the Labor Department showing U.S. unemployment rate dropped to 8.3 percent, the lowest since February 2009. Payrolls rose by 243,000, exceeding the most optimistic forecast in a Bloomberg News survey.

Accelerate Next Year

The jobless rate may fall below 8 percent by the end of 2012, Bullard said in response to audience questions. Economic growth may exceed 3 percent this year and accelerate in 2013, he said.

The Standard & Poor’s 500 Index declined 0.3 percent to 1,341.43 at 11:37 a.m. in New York. The yield on the benchmark 10-year Treasury note was unchanged at 1.92 percent.

Among Fed policy makers, Bullard, 50, has been viewed as a bellwether for investors. His speeches and interviews moved the two-year Treasury yield more than any other Federal Open Market Committee member last year, according to a Macroeconomic Advisers report released Jan. 27.

Bullard joined the St. Louis Fed’s research department in 1990 and became president of the regional bank in 2008. His district includes all of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee.

Bernanke told Congress last week that the Fed wouldn’t tolerate higher inflation to create jobs.

To contact the reporter on this story: Steve Matthews in Atlanta at smatthews@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net

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