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Fed's Lacker warns on monetary policy "thresholds" plan

Richmond Federal Reserve Bank President Jeffrey Lacker speaks during the Charlotte Chamber's Economic Outlook Conference in Charlotte, North
Richmond Federal Reserve Bank President Jeffrey Lacker speaks during the Charlotte Chamber's Economic Outlook Conference in Charlotte, North

By Jonathan Spicer

NEW YORK (Reuters) - A top Federal Reserve official on Tuesday challenged an idea that is gaining traction at the U.S. central bank, arguing that adopting so-called thresholds to guide policy would be a risky move that fails to take into account broader economic conditions.

Richmond Fed President Jeffrey Lacker also floated the idea that legislation might be necessary to limit the Fed's emergency lending activities, if the central bank cannot limit itself.

But Lacker spent much of his speech pouring cold water on an idea publicly endorsed by a few Fed policymakers, including influential Vice Chair Janet Yellen: setting specific rates for unemployment and inflation as markers for when the Fed would consider lifting interest rates.

"Crisp numerical thresholds may work well in the classroom models used to illustrate policy principles, but one or two economic statistics do not always capture the rich array of policy-relevant information about the state of the economy," Lacker said at a meeting of the Shadow Open Market Committee, a private organization that analyzes monetary policy.

Lacker, an inflation hawk who has dissented at every Fed policy-setting meeting this year, said placing great weight on the jobless rate alone "can easily lead you astray," given the complexity of factors that influence the labor market.

Adopting an inflation threshold, in particular, "essentially requires that we lose a measure of credibility before it can be invoked," he said. This is because even if the unemployment rate remains stubbornly high, a rise in inflation would be necessary to finally reverse monetary policy, he added.

HOT DEBATE

The idea of thresholds has been increasingly debated at the last few policy meetings of the central bank. A few of the Fed's 19 policymakers have even pitched their own specific proposals, including Chicago Fed President Charlie Evans, credited with hatching the plan.

Evans, for example, wants ultra-low rates as long as the jobless rate remains above 7 percent - unless inflation rises to 3 percent. U.S. unemployment was 7.9 percent last month, while inflation has remained slightly below the Fed's 2-percent target.

Fed Chairman Ben Bernanke may weigh in on the debate in a speech later on Tuesday in New York.

The thresholds would likely replace the Fed's use of a calendar date - currently mid-2015 - to signal how long it expects to keep rates near zero, where they have been since late 2008 to help the U.S. economy recover from the recession.

Lacker said the calendar date can confuse investors who misinterpret it as Fed pessimism on the state of the economy. He argued the Fed could "provide some sense of the economic conditions under which it's likely to begin raising rates and reducing the size of its balance sheet."

"But it's important to avoid spurious precision," he said.

The central bank has also bought more than $2.3 trillion in assets to boost the recovery and get Americans back to work.

Turning to lending, Lacker criticized what he called "expansive central bank lending," and warned that "establishing credible limits" could be difficult. The policymaker has in the past made the case against "discretion" in emergency Fed lending.

"One could imagine legislation that limits the Fed to a narrowly defined set of ordinary lending activities — very short-term lending to sound, solvent banks, against good collateral, at rates above interbank market rates," he said.

"If the Federal Reserve cannot limit credit policy of its own accord, legislation may be the best option."

(Reporting by Jonathan Spicer; Editing by James Dalgleish and Chizu Nomiyama)

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