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Taylor: Fed Should Stop Treasury Buys

By Julie Crawshaw   |   Thursday, 25 Jun 2009 05:02 PM

Stanford University economist John Taylor said a rise in mortgage rates and inflation are right around the corner "unless the Fed presents a clear and credible exit strategy from the unprecedented explosion of its balance sheet."

Taylor said the Fed should immediately start to wind down its purchases of Treasury bonds.

Taylor is famous among economists for the "Taylor rule," which describes how the Fed should adjust interest rates based on inflation and economic growth.

He said the negative effects of the Fed's easy money already may be apparent in "increasing oil prices and mortgage rates, which will be a drag on the recovery."

The Fed left its benchmark short-term interest rate at its current level near zero at this week's meeting, adding later it would extend some liquidity programs like the TALF while curtailing their reach.

Dino Kos, managing director at the research firm Portales Partners and a former top Fed official, said as long as the weak economy chills demand for credit, the free-flowing central bank cash poses no inflation threat.

But Kos agreed the Fed will have to time its exit strategy just right.

"If this is kindling right now, there is no spark to get it going," he said, adding that the Fed must be vigilant because "there's some sparks that are getting closer."

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