U.S. unemployment remains "painfully high" while inflation is not an immediate concern, giving the Federal Reserve plenty of reason to launch a new stimulus last month, a top Fed official said on Thursday.
Jeremy Stein, in his first keynote speech since becoming a Fed governor in May, said he strongly supported the U.S. central bank's decision to embark on a new, open-ended bond-buying program.
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His comments suggest that despite cries of foul from a handful of hawkish regional Fed bank presidents, Fed Chairman Ben Bernanke had solid backing for the third round of quantitative easing, or QE3, announced in September.
Stein said the plan was needed to boost an economy that was growing too slowly to bring down the nation's unemployment rate, currently at 7.8 percent.
"It appears that the economy is growing at a pace such that, absent policy action, progress on reducing unemployment will likely be slow for some time," Stein told an event at the Brookings Institution. "Given where we are, and what we know, I firmly believe that this decision was the right one."
U.S. economic growth registered a paltry 1.3 percent annual rate in the second quarter and economists polled by Reuters see a still anemic 1.7 percent clip for the third quarter.
Stein offered a detailed explanation of how he estimates the effect of the new asset purchases will help economic growth. The purchases kick off with $40 billion per month in mortgage-bond buying.
He estimated a hypothetical $500 billion in Treasury purchases would lower yields on benchmark 10-year U.S. Treasury notes by about 0.15-0.20 percentage point. Stein added there was a boost to stock prices and corporate bond markets as well.
But he said there was an even deeper impact from the psychological boost to confidence among consumers and businesses.
"(The) overall impact of (asset buys) may be augmented via a signaling or confidence channel," Stein said.
Describing some of the potential costs of unorthodox monetary easing from the Fed, Stein concluded - like the policy-setting Federal Open Market Committee - that the risks are manageable and worth taking. He said the Fed has the tools and the will to raise interest rates if inflation becomes a problem.
FED ON BUBBLE WATCH
Stein said the Fed is cognizant of the possibility that low interest rates could lead to asset bubbles by forcing investors to take undue risks, and that the Fed would monitor such prospects closely.
But he added current conditions offer little cause for alarm, arguing low rates may actually contribute to financial stability by making it easier for firms to rely less heavily on short-term financing.
He pushed back against the notion that the Fed might be shooting for higher inflation, saying this would risk the central bank's credibility without offering any obvious benefits.
"I disagree with the premise that what we're doing is seeking to gin up inflation," Stein said in response to questions from the audience.
Stein also dismissed the notion that easy monetary policy only helps wealthy individuals by boosting stock prices. On balance, lower income earners tend to have higher debt levels, he said, and are therefore net beneficiaries of the Fed's ultra-low rates.
He acknowledged that the weakening of the dollar that tends to accompany the Fed's monetary stimulus is of some benefit to economic growth but argued that this is not a dominant channel through which Fed policy affects the economy.
In response to the financial crisis and deep recession of 2007-2009, the Fed cut official rates to effectively zero and more than tripled its balance sheet to around $2.8 trillion.
(Editing by Neil Stempleman and James Dalgleish)