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Fed Easing May Harm Long-Term Economic Growth, Warsh Says

Former Federal Reserve Governor Kevin Warsh said the central bank’s record monetary easing may set back the U.S. economic expansion and that he’s concerned policy makers are pushing investors into riskier assets.

“Recent policy activism -- measures that go beyond a central bank’s capacity or traditional remit -- threatens to forestall recovery and harms long-term growth,” Warsh said in a speech today in Stanford, California. The former governor said he hopes the Fed’s pledge to hold rates low until at least late 2014 isn’t seen as a “guarantee” that “reacquaints consumers with bad habits.”

Warsh joined the Fed in February 2006, the same month Ben S. Bernanke became chairman, and served as one of Bernanke’s closest advisers during the financial crisis. Both policy makers were appointed by then-President George W. Bush and worked to calm markets after the September 2008 bankruptcy of Lehman Brothers Holdings Inc.

The former policy maker said he’s not “terribly comfortable with the idea of pushing consumers into riskier assets,” which is the impression left by the Fed’s decision yesterday to keep the benchmark U.S. interest rate near zero through at least late 2014. He also criticized the Fed for unveiling policy makers’ projections for the path of interest rates, and voiced doubt about the central bank’s new inflation target.

New Policy?

“It’s difficult for me to understand whether or not the Federal Reserve over the last couple of days instituted a new policy,” by possibly allowing inflation to rise above 2 percent to bring down unemployment, he said at the Stanford Institute for Economic Policy Research.

Nine of the 17 officials who participate in FOMC meetings predict borrowing costs will remain below 1 percent at the end of 2014, with six officials expecting zero rates to last into 2015, according to forecasts released yesterday.

Warsh is now a visiting fellow at Stanford University’s Hoover Institution and works as a consultant to investors. His clients include the Duquesne Family Office, which Stanley Druckenmiller created to manage his own money after closing his hedge fund, Duquesne Capital Management.

While Warsh voted for the central bank’s large-scale asset buying programs, he questioned the $600 billion in Treasury purchases announced in November of 2010. He said the purchases posed “nontrivial risks” in a speech and opinion article a few days after the Fed’s announcement.

Challenged Idea

Today, he went further and challenged the idea that new asset purchases would help the economy. “I don’t believe balance-sheet expansion at this moment passes the benefit-cost test,” Warsh said in response to audience questions.

The former Fed governor also said that while the central bank has done a “reasonable job” of holding down long-term bond yields, he would be “more comfortable” if private market participants were setting long-term interest rates.

The speech constitutes Warsh’s first public comment since he retired from the central bank in April. During his tenure as governor, he never dissented from a decision by the policy-setting Federal Open Market Committee. He said today “exceptionally accommodative monetary policy can provide important transitional support for an economy.”

Warsh was an architect of the terms the U.S. Treasury dictated to nine of the biggest U.S. banks in October 2008 in return for a $125 billion injection of government funds.

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