Tags: Dudley | Fed | Rush | Tighten | Policy | us | economy

Dudley: Fed Shouldn’t Rush to Tighten Policy ‘Too Early’

Monday, 11 Apr 2011 10:33 AM

The U.S. Federal Reserve shouldn't be too enthusiastic about tightening monetary policy soon as there is still significant slack in the economy, a top central bank official said on Monday.

Oil prices could push up headline inflation, but central bankers shouldn't over-react as this is likely to be temporary and could lead to a monetary policy mistake, New York Federal Reserve Bank President William Dudley said after giving a speech in Tokyo.

U.S. economic activity has slowed in the past few months as oil prices weigh on sentiment, Dudley said. Economic recovery isn't assured and wage growth remains low, he said.

"We shouldn't be enthusiastic about tightening monetary policy too soon," Dudley said.

"If inflation expectations became unanchored, the Fed would have to respond. I don't see any signs that expectations are becoming unanchored."

The president of the New York Fed has a permanent voting seat on the Fed's policy-setting panel. His recent views have been "dovish" on inflation, but other central bankers have argued that the central bank needs to exit its ultra-easy monetary policy.

The Fed has kept interest rates near zero since December 2008 and launched a $600 billion bond-purchase program in November to further support the U.S. economic recovery.

At its last meeting, the Fed unanimously voted to stick to the bond purchase program which is due to end in June.

The Fed next meets on April 26-27.

There is still significant slack in the U.S. economy as unemployment is high and wage growth low, Dudley said. Headline consumer prices in the United States could rise at a slower rate than in other countries because prices are starting at a lower base, he also said.

Minutes from the Fed's last policy meeting showed that some central bankers had started to think about hiking interest rates before the end of this year, but views within the Fed are split over how quickly to withdraw from its accommodative monetary policy. 

The latest reading on the Fed's preferred inflation gauge showed it was up 1.6 percent year on year, still below the 2 percent comfort zone held by many Fed officials.

Still, many Fed officials now fear inflation could start to accelerate as rising commodity prices flow into the U.S. economy through higher food and energy costs.

The U.S. economy is still not strong enough for the Fed to start reversing its extremely accommodative monetary policy, Fed Vice Chair Janet Yellen said on April 9. In contrast, Dallas Fed President Richard Fisher said a day earlier the Fed needed to stop "spiking the punch bowl." 

Both Yellen and Fisher vote on monetary policy.

With memories of the 2007-2008 financial crisis already fading, some banks are calling for a return to "business as usual," a call that regulators should reject, Dudley said earlier in prepared remarks.

"We have seen that 'business as usual' results in unacceptable outcomes," he said.

"As the crisis recedes in memory, the natural reflex will be to relax and grow complacent."

Global regulators are devising reams of rules designed to push banks toward less risky business strategies and avoid taxpayer bailouts by ensuring financial institutions have enough reserves to withstand shocks.

While acknowledging that global regulators have made headway in some areas, "We have much more to do to ensure that we have a relatively level playing field," Dudley said.

Banks deemed to be systemically important should be required to hold common equity above and beyond the minimums for other banks, Dudley said. Such a surcharge not only would act as a buffer in the event of a shock, but would also keep them from gaining a competitive funding advantage just by being bigger.

And regulators need to share information about systemically important institutions, he said, and about trades in over-the-counter derivatives, where risky bets contributed to the recent crisis.

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The U.S. Federal Reserve shouldn't be too enthusiastic about tightening monetary policy soon as there is still significant slack in the economy, a top central bank official said on Monday. Oil prices could push up headline inflation, but central bankers shouldn't...
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