ST. LOUIS (Reuters) - Large-scale bond buying can be an effective monetary policy substitute when the Federal Reserve runs out of room to cut interest rates, a top official of the U.S. central bank said on Thursday.
Speaking on the final day of the Fed's latest bond-buying initiative, James Bullard, president of the St. Louis Federal Reserve Bank, pronounced the purchases, which have totaled $2.3 trillion in all, successful in easing financial conditions.
"This experience shows that monetary policy can be eased aggressively even when the policy rate is near zero," he said at a St. Louis Fed conference evaluating quantitative easing.
Bullard qualified his assessment by saying the effects of bond buying on reviving the economy are harder to evaluate and have been clouded by shocks, including disruptions from the Japanese earthquake and European debt problems.
The Federal Reserve exhausted its conventional tools when it cut short-term interest rates to near zero in December 2008.
Since then the Fed has sought to provide an additional boost to the economy via two asset-buying programs -- with the second program dubbed QE2 -- effectively showering the banking system with money to try to spur lending. Economists call this tactic quantitative easing.
Bullard is a voting member of the Fed's policy-setting Federal Open Market Committee this year and is viewed as a centrist among Fed policy makers. His remarks suggest that if the central bank decides the recovery needs another jolt, at least one official would view more bond buying as an effective tool.
The Fed has signaled it is not immediately planning to renew bond purchases, although it has pledged to reinvest maturing securities to prevent its balance sheet from shrinking. Fed Chairman Ben Bernanke said last week that while the recovery is still weak, rising inflation means economic conditions are different than those that led the Fed to launch the initiative last November.
FED SHOULD ACT IF GROWTH DISAPPOINTS
The Fed, however, may come under pressure to take further action, with growth clocking an anemic 1.8 percent annualized rate in the first quarter and with unemployment still at an elevated 9.1 percent.
Bullard said the Fed should take a breather and gather more information before taking any further steps, but if developments are disappointing, policy makers should be prepared to act.
"If the economy's not performing well, then the committee should consider taking additional action," Bullard told reporters.
"However the situation today is very different than last summer, especially on the inflation side," he added.
U.S. inflation has risen in recent months on higher energy and food prices. The Fed believes those increases are transitory but bear close watching.
One Fed official who is not likely to support more bond buying is the president of the Kansas City Fed, Thomas Hoenig, who said on Thursday that keeping interest rates near zero for an extended period is sowing the seeds of future economic instability.
An anti-inflation hawk who had opposed the Fed's second round of quantitative easing, Hoenig reiterated his concerns that ultra-low rates can generate bubbles elsewhere.
"An extended zero-interest rate policy is producing new sources of fragility that we need to be aware of," he told the Rotary Club of Des Moines, Iowa.
ECONOMIC IMPACT OF QE2 IS DELAYED
Many academics agree that quantitative easing has, in fact, been an effective monetary policy tool when interest rates are near zero.
The Fed's policy has lowered interest rates on longer-term securities and pushed many investors to take on risker assets, economists at the St. Louis conference said.
The Bank of England's own quantitative easing program has lowered yields on British government securities by 100 basis points, a Bank of England economist, Michael Joyce, said at the conference.
The Fed's bond-buying program, however, has drawn sharp criticism from many for risking inflation and contributing to rises in food and energy costs around the world. Others have questioned its effectiveness.
Bullard said on Thursday that while the bond-buying program impacted financial markets immediately, its effect on the broad economy will lag by as much as a year.
"The effects of QE2 would be expected to lag by six to 12 months," Bullard said.
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