December 14, 2012 / 1:32 PM / in 7 years

Fed hawks take aim at central bank's latest policies

WASHINGTON/CHICAGO (Reuters) - Two top Federal Reserve officials on Friday raised questions about the U.S. central bank’s unprecedented decision to tie monetary policy to specific economic guideposts, and warned that its latest policy actions risk straying into fiscal territory.

The Federal Reserve building is seen in Washington June 19, 2012. REUTERS/Yuri Gripas

The Fed on Wednesday vowed to keep interest rates low until unemployment falls to at least 6.5 percent, as long as inflation does not threaten to rise above 2.5 percent.

It was the first time the Fed had picked a specific marker for unemployment to guide policy.

“I do not believe that tying the federal funds rate to a specific numerical threshold for unemployment is an appropriate and balanced approach to the FOMC’s price stability and maximum employment mandates,” Richmond Federal Reserve President Jeffrey Lacker said in a statement, referring to the Fed’s policy-setting Federal Open Market Committee.

Lacker was the lone dissenting voter on Wednesday’s decision, which also saw the Fed promise to buy $45 billion in longer-term Treasuries each month, on top of its monthly purchases of $40 billion in mortgage-backed securities, until it sees a substantial improvement in the outlook for the U.S. labor market.

The Fed will fund the new Treasury purchases with an expansion of its $2.9 trillion balance sheet. Under the expiring “Operation Twist” program, the Fed bought an identical amount, but paid for them with proceeds from sales and redemptions of short-term debt.

“With economic activity growing at a modest pace and inflation fluctuating close to 2 percent ― the Committee’s inflation goal — further monetary stimulus runs the risk of raising inflation and destabilizing inflation expectations,” Lacker said.

Dallas Fed President Richard Fisher, who does not have a vote on the policy-setting panel until 2014, also said he fought the recent decision.

“I argued that basically we were at risk of what I call a ‘Hotel California’ monetary policy,” Fisher said in an interview with CNBC, referring to an Eagles song about a hotel from which leaving is impossible. “Theoretically we can check out any time we want from this program, but practically, since we’re going to have an engorged balance sheet, we may never be able to leave this position.”

Fisher said he was concerned about the Fed’s new approach of setting thresholds for its policy in part because of possible confusing messages to the public.

Though the Fed has now picked an unemployment threshold, it’s not a “hard, fixed number” but rather a guidepost that must be taken in context with other indicators of labor market health, he said.

“I’m a little bit worried we are getting tangled up in our own knickers here,” he said.

To Fisher, setting an unemployment threshold also puts the Fed “closer and closer” to fiscal policy, because only fiscal, not monetary, policy can influence employment.

Lacker also worried the Fed’s new policies strayed into fiscal territory, which is the purview of Congress. He said that buying mortgage-backed bonds means the Fed was favoring housing over other parts of the economy.

“Deliberately tilting the flow of credit to one particular economic sector is an inappropriate role for the Federal Reserve,” Lacker said, adding that trying to influence credit allocation within the economy was a function of fiscal policy.

Editing by Chizu Nomiyama

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