Federal Reserve Bank of Kansas City President Esther George said the Fed’s record stimulus may fuel the risk of financial instability and a surge in inflation.
“A prolonged period of zero interest rates may substantially increase the risks of future financial imbalances and hamper attainment of the” Fed’s 2 percent inflation goal, George said today in a speech in Kansas City, Missouri.
Fed officials are debating when to end purchases of mortgage bonds and Treasury securities that are aimed at fueling economic growth and reducing 7.8 percent unemployment. Policy makers decided last month to hold the target interest rate near zero so long as unemployment remains above 6.5 percent and inflation stays below 2.5 percent. George holds a vote on the Federal Open Market Committee, which next meets Jan. 29-30.
Since becoming leader of the Kansas City Fed in October 2011, George has spoken mainly about financial regulation. Her predecessor, Thomas Hoenig, dissented from policy actions in 2010 and called for raising the benchmark interest rate from near zero percent.
Asset purchases by the Fed, now totaling $85 billion per month, will “almost certainly increase the risk of complicating the FOMC’s exit strategy” because bonds will need to eventually be sold, George said.
“Like others, I am concerned about the high rate of unemployment, but I recognize that monetary policy, by contributing to financial imbalances and instability, can just as easily aggravate unemployment as heal it,” George said to the Central Exchange, a group that promotes leadership development for women.
Prices “of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels” and may signal market imbalances, George said.
Low interest rates and stronger demand for agricultural commodities stoked a rise in land prices, she said in response to audience questions.
“We have to watch that carefully,” she said, adding that it’s too early to be alarmed. “I would be the last to suggest I can identify when there is a bubble there.”
In prepared remarks, George said, “the exceptionally long period of extraordinary monetary policy accommodation could also become a threat to the stability of longer-term inflation expectations.”
The U.S. economy has been restrained by households cutting their debt, corporations hoarding cash amid uncertainty about fiscal policy and banks repairing their balance sheets, George said.
Still, “key sectors” of the economy including housing and auto industries are showing improvement, the Kansas City Fed leader said. “I expect that the economy will continue to grow a bit more than 2 percent in 2013 and that the level of unemployment will continue to decline, perhaps by another half a percentage point,” she said.
The U.S. economy may expand at a 2 percent pace in 2013 after a 2.3 percent gain last year, according to the median forecast among economists surveyed by Bloomberg News this month.
St. Louis Fed President James Bullard said at a different event that policy makers may have difficulty tying the central bank’s monthly bond purchases to numerical levels of unemployment and inflation.
“Attempts to also put thresholds on the timing of asset purchases may be a bridge too far,” Bullard said today to the Wisconsin Bankers Association in Madison, Wisconsin.
U.S. stocks gained for a second day, returning the Standard & Poor’s 500 Index to a five-year high. The Standard & Poor’s 500 Index rose 0.6 percent to 1,469.96 at 2:55 p.m. in New York.
George, 54, was the Kansas City Fed’s No. 2 official under Hoenig, who retired and was later named vice chairman of the Federal Deposit Insurance Corp. She joined the Fed in 1982, spent much of her career in bank supervision and became first vice president in 2009.