Fed’s Hoening: Room to Raise Rates Without Hurting Recovery
The Federal Reserve could increase key rates toward 1% from near zero as a ward against inflation and doable bubbles in financial markets without hurting the nascent economic recovery, a Fed official said Wednesday.
The lone dissenter on the rate-setting Federal Open Markets Committee said 1% rates, which the Fed could go toward “a small time soon,” would still represent “highly accommodative” monetary plot.
“This would require initiating a reversal of plot earlier in the recovery, while the data are still mixed but generally clear,” said Thomas Hoenig, the president of the Reserve Bank of Kansas City.
Current Fed plot, which states that key rates will wait ultralow for an “extended period” is no longer needed, Hoenig spoke at a luncheon in Santa Fe, N.M., delivering a speech from a prepared text entitled, “What About Zero?”
“By itself, the current state of the economy warrants an accommodative monetary plot,” Hoenig said. “But, as the economy continues to increase, risks emerge around the act of holding rates low for an extended period.”
Hoenig dissented from the “extended period” language at the past two FOMC meetings because of concern that artificially low rates can make monetary imbalances, chief investors to invest cheap money based on the expectations of the key Federal Assets rate being held near zero.
The market, Hoenig said, interprets “extended period” to mean at smallest amount six months.
Interest rates set near zero for too long could lead to a new bubble and an inevitable bust, or even financial collapse, he said.
While Hoenig said he could not “reliably identify” or “prick” an economic bubble in a timely fashion, holding rates at ultralow levels for an extended period “encourages bubbles because it encourages debt over equity and consumption over savings.”
With the U.S. economy likely to grow around 3% for 2010, and with the weak labor market seen as stabilizing, the Fed could initiate an increase in key rates to 1%, ending the “borrowing subsidy” more quickly, and moderating credit conditions, he said.
Raising key rates also would lessen the opportunity of inflation, though Hoenig said inflation would likely wait low for the next year or two.
“Under this plot course, the FOMC would initiate some time soon the process of raising the federal assets rate butt toward 1%,” Hoenig said. “I would view a go to 1% as simply a continuation of our strategy to remove measures that were originally implemented in response to the intensification of the financial crisis.”