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Fed Can Avoid A ‘bad Inflation Outcome’

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Dudley Says Fed Can Avoid a ‘Bad Inflation Outcome’ (Update3)

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By Michael McKee

Aug. 31 (Bloomberg) -- New York Federal Reserve Bank President William Dudley said the Fed has the tools to prevent inflation from accelerating and doesn’t need to begin trimming its balance sheet.

“It’s a little bit premature to be so confident that you want to pull all these things back right now, because the economy still isn’t growing very fast and we do have a very high unemployment rate,†Dudley said today in an interview on CNBC.

Dudley’s comments are in contrast to those of two Fed district bank presidents, Jeffrey Lacker and James Bullard, who said the central bank may not need to buy the full $1.25 trillion in mortgage-backed securities that has been authorized by year-end. Richmond’s Lacker and Bullard, of St. Louis, spoke at separate events last week.

“Obviously, as financial conditions improve, as the economy does somewhat better, which seems to be the trajectory they’re on, it’s a legitimate point to consider what you want to do in terms of your purchase programs,†Dudley said today.

The central bank, seeking to stimulate the economy and unclog credit markets, has created emergency lending programs and doubled the size of its assets during the past year to more than $2 trillion.

The Fed’s program to buy mortgage bonds guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae is aimed at reducing home-finance costs and arresting the housing slump that triggered the recession. The central bank also intends to buy $300 billion of long-term Treasuries and $200 billion of federal agency debt.

Large Expansion

Dudley said it’s “more likely than not†that policy makers will follow through with the full amount of purchases. While he hasn’t decided how he would vote, investors’ expectations will influence his opinion on the issue, he said.

“The market expects us to complete these programs, to do the full amount,†he said. “To contradict that market expectation is a pretty high hurdle.â€

Mortgage-backed securities purchases “have been very effective,†he said. “There’s no question that has actually helped.â€


Planning for Exit

Dudley said the Fed is “far along†in its planning for an exit from the extraordinary policy actions of the past year. Along with paying interest on excess reserves, the central bank may also do reverse repurchase agreements, lending securities into the market in exchange for cash, and create special interest-bearing accounts at the Fed for banks to deposit their excess reserves.

The timing for various aspects of the exit “remains to be seen†because the Fed will need to weigh the desired impact on parts of the market: mortgage rates or short- or long-term rates, he said. “We’re going to base it on the facts at this time, which I think is quite a long period away.â€

The New York Fed president said he wouldn’t give in to any political pressure to keep interest rates low for too long.

“I am committed to taking away the punch bowl at the right time,†he said. “I have no desire whatsoever to see inflation get out of control.â€

The health of the banking system is a worry, with “a tremendous amount of additional credit losses†expected, Dudley said. “The banking sector is not as good as it normally would be at this stage of the economic cycle.†...

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