Dudley Says Fiscal Debate Among Risks to Economic Outlook

Federal Reserve Bank of New York President William C. Dudley said budget battles in Washington are among the risks to the outlook and he wants to see more momentum in the economy before paring the pace of the central bank’s bond buying.

Debate in Congress on raising the debt ceiling and how to fund the government for the next fiscal year “creates uncertainty about the fiscal outlook and may exert a restraining influence on household and business spending,” Dudley said today in a speech in Syracuse, New York.

The Fed last week unexpectedly held off on reducing its $85 billion monthly pace of asset purchases, saying it needs more evidence of lasting improvement in the economy. Chairman Ben S. Bernanke said on Sept. 18 after the two-day meeting the central bank must determine policy based on “what’s needed for the economy,” even if it surprises investors.

“I’d like to see economic news that makes me more confident that we will see continued improvement in the labor market,” said Dudley, who holds a permanent vote on policy as vice chairman of the Federal Open Market Committee. “Then I would feel comfortable that the time had come to cut the pace of asset purchases.”

U.S. stocks fell, extending a weekly drop, amid concern the political impasse over the federal budget will hurt the economy. The Standard & Poor’s 500 Index declined 0.5 percent to 1,690.90 at 3:52 p.m. in New York. The yield on the 10-year Treasury note dropped three basis points to 2.62 percent.

Sustained Buying

Investor expectations this year about when the Fed would taper “jumped the gun,” Dudley said in response to audience questions. Policy makers had said reductions in bond buying hinge on economic data and they never pledged to slow their buying this month, he said.

“Markets got a little ahead of us and it just underscores the importance of Fed communication,” Dudley told business school students at Syracuse University. “What we were trying to do this summer was to really just provide a little bit more context for how we were going to think about the decision how to reduce the pace of asset purchases when the time came.”

The FOMC would be leery of allowing inflation to rise above its 2 percent target, Dudley said.

“We think it’s not a good policy to try a little bit more inflation above the 2 percent target by any significant margin because we tried that in the ’60s and ’70s and it didn’t end well,” he said. “What they found out was they were trading a little lower unemployment for ever-higher inflation.”

Policy makers are “very much committed to not making that mistake again,” he said.

Inflation Policy

Dudley, 60, said in the speech that rising domestic interest rates and the global economic outlook pose risks to the U.S. economy. The average rate on a 30-year fixed-rate mortgage was 4.32 percent in the week ended Sept. 26, compared with 3.51 percent on May 16, the week before Fed Chairman Ben S. Bernanke first outlined a possible timetable for a reduction in asset purchases.

“We have seen a sharp drop in refinancing mortgage applications, a more moderate but significant decline in purchase mortgage applications and fairly flat housing starts and new-home sales,” Dudley said. “These developments do suggest that higher mortgage rates have cut into the upward momentum of the housing sector.”

Fed officials last week reduced their growth estimates for this year and next. Gross domestic product will probably rise 2 percent to 2.3 percent this year, down from a June projection of 2.3 percent to 2.6 percent, according to their estimates.

Labor Market

“Consistent with the modest pace of economic growth, improvement in labor market conditions has been slow,” Dudley said. “Taken together, the labor market still cannot be regarded as healthy. Numerous indicators, including the behavior of labor compensation, are all consistent with the view that there remains a great deal of slack in labor markets.”

Employment growth has improved with the Fed’s bond purchases, which have expanded its balance sheet to a record $3.73 trillion. The U.S. has added an average of 160,000 jobs over the past six months, up from 97,000 originally reported for the half-year before the Fed decided to start the third round of purchases a year ago. Policy makers will get another jobs report before their next gathering on Oct. 29-30.

Dudley said in a Sept. 23 speech that policy makers must “forcefully” push against economic headwinds as growth hasn’t shown “any meaningful pickup” in momentum.

Support Needed

“The economy still needs the support of a very accommodative monetary policy,” Dudley said in his speech in New York.

Dudley said in an interview with CNBC that aired Sept. 24 that the central bank may still slow the pace of purchases in 2013 depending on the economy’s performance.

“If the economy were behaving in a way aligned with the Fed’s June forecast, then it’s certainly likely that the Fed would begin to taper later this year,” Dudley told CNBC. “I certainly wouldn’t want to rule it out. But it depends on the data.”

Dudley was chief U.S. economist for Goldman Sachs Group Inc. from 1996 to 2005 before joining the Fed regional bank in 2007. He served as the New York Fed’s head of markets before becoming president of in 2009, succeeding Timothy F. Geithner when he became Treasury secretary. Dudley holds an economics doctorate from the University of California at Berkeley.

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