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Fed doves make case for patience on tightening policy

An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst
An eagle tops the U.S. Federal Reserve building's facade in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Ann Saphir, Balazs Koranyi and Jonathan Spicer

MINNEAPOLIS/OSLO/NEW YORK (Reuters) - The Federal Reserve must be patient in deciding when to scale back bond purchases, top officials said on Friday, with one arguing it could wait "years" to lift interest rates and another suggesting it could tolerate inflation rising to 3 percent.

The dovish remarks, by Chicago Fed President Charles Evans, Minneapolis Fed chief Narayana Kocherlakota and New York Fed boss William Dudley, came as investors reviewed expectations on whether the Fed will begin to taper bond buying this year or next, after it unexpectedly decided last week to stand pat.

Evans, speaking in Oslo, said the economic outlook suggested that a reduction in the level of bond purchases was in order, but that when to begin that process is not yet certain.

"Whether or not we'll have enough confidence at the October meeting or the December meeting, I just can't say that with a lot of certainty," he told reporters. "I think there's a decent chance of that. But it could go a little bit longer," he said.

Financial markets were stunned when the Fed's policy-setting committee announced at the end of its meeting last week that it would keep buying bonds at a monthly pace of $85 billion.

Kocherlakota, in an interview with Reuters, said the volatility in financial markets following the policy decision, which sparked complaints the central bank had failed to communicate properly, exposed the need for the Fed to re-think how it guides expectations.

"What went wrong is the fact that we don't have a comprehensive strategy in place that is credible. ... We do not have a comprehensive form of forward guidance."

WHATEVER IT TAKES

Kocherlakota said the Fed should do "whatever it takes" to achieve its goal of maximum sustainable employment.

"If that announcement is credible, (it) has enormous power in and of itself," said Kocherlakota, who does not vote on Fed policy in 2013.

The Fed launched its third round of so-called quantitative easing, or QE3, in September, and said it would keep buying bonds until it saw a substantial improvement in the outlook for the labor market.

The jobless rate has since declined to 7.3 percent in August versus 8.1 percent a year ago. But it is still historically high and even the drop in August was attributed to the many discouraged job-seekers who have given up looking for work.

Kocherlakota said scaling back the purchase program last week would have sent the wrong message to markets - that the Fed was satisfied with weak growth and slack employment.

"That doesn't make sense. That is not doing whatever it takes to bring employment up...to maximum as fast as possible," he said.

The Fed cut interest rates to almost zero in late 2008 and has more than tripled the size of its balance sheet to around $3.6 trillion, through 3 massive campaigns of bond buying, in a bid to spur growth and hiring by holding down borrowing costs.

However, long-term rates rose sharply after the Fed began talking about scaling back bond buying in May, and after Fed Chairman Ben Bernanke said in June that officials expected to begin tapering later this year, and end the program by mid-2014.

To hold down borrowing costs, the Fed also says it will keep its overnight funds rate near zero until unemployment hits 6.5 percent, provided that the outlook for inflation remains under 2.5 percent.

ON HOLD FOR "YEARS"

New York Fed President Dudley said that could be a while.

"The amount of time that can pass between the decision to begin to taper and actually raising short-term interest rates could easily be a number of years," he said in New York.

Fed officials last week refreshed quarterly forecasts for the U.S. economy, with 12 anticipating they would first raise rates in 2015.

The median of their projections for 2016 judged that overnight fed funds rates would have reached 2 percent by the end of that year, when the central tendency of their forecasts for inflation was 1.7 percent to 2.0 percent.

The U.S. central bank's stated goal for inflation, measured by the personal consumption expenditures index, or PCE, is 2 percent. The PCE ticked down to 1.2 percent in August, though it was still up from 0.9 percent in April.

Evans said that flexibility on inflation could well be necessary, and may require even greater forbearance from the central bank, as policy-makers pursue their other objective, of achieving maximum sustainable employment.

"That's not a goal but it could be a feature, in order to have accommodating conditions that support maximum employment, so that's really very helpful," Evans said. "We could even do this as long as inflation was below 3 percent, because I think symmetry around the inflation target is incredibly important."

Evans has previously suggested holding rates near zero until either the unemployment rate drops under 7 percent, or the outlook for inflation rises above 3 percent.

(Writing by Alister Bull; Editing by Leslie Adler and Chizu Nomiyama)

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