The U.S. Federal Reserve cannot "wave a magic wand" to fix the economy overnight, but it can provide "essential" support, a top Fed policymaker said on Monday.
Indeed, support will likely be warranted unless economic conditions improve, William Dudley, president of the New York Fed and a permanent voter on the Fed's policy-setting panel, said in a speech at Cornell University.
His comments underline market expectations that the Fed will buy more long-term assets at its next policy-setting meeting on Nov 2-3 to try to revive the economic recovery.
The U.S. central bank cut interest rates to near zero and bought $1.7 trillion in mortgage-related and Treasury debt to try to boost the economy during the global financial crisis.
However, a Fed colleague known for steady opposition to easy monetary policies said further easing would be a "dangerous gamble" that could set in motion another wrenching boom and bust cycle.
"There are real risks to quantitative easing," Kansas City Federal Reserve Bank President Thomas Hoenig said in Lawrence, Kansas, referring to extensive asset purchases by the Fed to push borrowing costs lower even though short-term rates are near zero.
Hoenig acknowledged he held a minority view on the Fed. He has used his voting status this year to dissent six times against Fed policies aimed at supporting the recovery.
Dudley, who has been among Fed officials making the case for monetary easing, said the road to full recovery is likely to be "long and bumpy". Momentum is slowing, he said.
"The Fed cannot wave a magic wand and make the problems remaining from the preceding period of excess vanish immediately," Dudley said. "But we can provide essential support for the needed adjustments."
Dudley repeated his view that high unemployment and low inflation were inconsistent with the Fed's mandate to maintain price stability and maximum employment.
"I said that I thought further Fed action was likely warranted unless the economic outlook were to evolve in a way that made me more confident we would see better outcomes for both employment and inflation before too long."
Hoenig, for his part, restated his belief that ultra low interest rates and a more than doubling of the Fed's balance sheet from pre-crisis levels risks creating asset bubbles and sets the stage for another crisis.
Although critics argue further support for the economy could prove inflationary, a former Fed chairman known for his inflation fighting commitment said inflation is unlikely to be a problem for years. Paul Volcker added he does not see the risk of a damaging spell of falling prices.
"Inflation is not a problem right now. It won't be a problem next year, it won't be a problem for several years," said Volcker, who is now chairman of the Obama administration's Economic Recovery Board, in Boston.
"I see no possibility, frankly, that deflation will take place," he added.
Fed Chairman Ben Bernanke has said signs the weak recovery could be at risk would appear to meet criteria for the Fed to provide further aid, and the debate among most observers is over the scope and pace of easing.
Dudley said whether an incremental approach to asset purchases, or a big-bang approach, would work best would depend on the economic context.
But he downplayed expectations for a November announcement of a new round of quantitative easing — known as QE2.
"I would put very little weight on what is priced in or not priced in to the market," Dudley said in response to reporters' questions. "With QE2 it is a careful assessment of the costs and benefits and to try to judge whether it makes sense to do it or not."
The prospect of further Fed easing has drawn the ire of emerging nations, who say its feeds a flood of capital into their markets as investors seek out higher yields, potentially destabilizing their economies.
However, Dudley said the dollar was not an objective for the U.S. central bank. If the Fed focused on its dual mandate of full employment and price stability, "the dollar will take care of itself," he said.
Dudley repeated that the Fed is closely monitoring U.S. foreclosures for their potential impact on housing and financial markets and the broader economy.
State and federal officials are investigating allegations that for years banks have not reviewed foreclosure documents properly or have submitted false statements to evict delinquent borrowers.
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