In the Media | April 2013

Kocherlakota Says Low Fed Rates Create Financial Instability

By Joshua Zumbrun
Bloomberg, April 18, 2013. All Rights Reserved.

Federal Reserve Bank of Minneapolis President  Narayana Kocherlakota said the central bank’s low interest-rate policies, though necessary, will probably generate signs of financial instability.

“Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity,” Kocherlakota said today in the prepared text of a speech in New York.  “All of these financial market outcomes are often interpreted as signifying financial market instability.” He told reporters later he doesn’t see financial instability as imminent.

Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds  and farmland.

While George has dissented from this year’s Federal Open Market Committee decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.

In speeches earlier this month, Kocherlakota said he sees an “ongoing modest recovery” with unemployment staying at 7 percent or more through late 2014. The slow recovery calls for “more accommodation,” he said in a speech, repeating his call to postpone consideration of any increase in interest rates. He doesn’t vote on policy this year.

Dual Mandate
“It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low,” Kocherlakota said at the Levy Economics Institute’s 22nd Annual Hyman P. Minsky Conference.

The Minneapolis Fed chief has said the central bank should hold its target interest rate near zero until unemployment  falls to 5.5 percent. That’s a percentage point below the 6.5 percent threshold that has been adopted by the FOMC.

Answering audience questions, Kocherlakota said the recovery in the housing market is evidence that the Fed’s monthly purchases of $85 billion in Treasuries and mortgage securities are effective.

“They are having an impact on the economy,” he said. “Look at what’s going on in the mortgage market.”

“It would be nice if we did even more along those lines because I think our tools have been effective,” he said. “In the housing market, in particular, you’ve certainly seen direct effects of that kind of stimulus.”

Growth Outlook
Kocherlakota told reporters that the current growth outlook is sufficient to raise inflation, currently measured at 1.3 percent by the Fed’s preferred price gauge, closer to the Fed’s goal of 2 percent.

“It’s very important to protect the target both from above, which gets so much attention, but from below as well,” he said.

“Given the stimulus we’re providing, given the growth I see in the economy, 2.5 percent in 2013, 3 percent in 2014, that kind of growth I see as sufficient to put upward pressure on inflation,” Kocherlakota said.

He said he’s already “in favor of more accommodation” and further declines in the inflation rate would make him “even more” supportive of additional stimulus.

In his speech, Kocherlakota said that “for a considerable period of time,” the FOMC may only be able to “achieve its macroeconomic objectives in association with signs of instability in financial markets. These financial market phenomena could pose macroeconomic risks. In my view, these potentialities are best addressed using effective supervision and regulation of the financial sector.”

“The low interest-rate environment” in coming years “will put even more pressure on the regulatory framework,” Kocherlakota told reporters after his speech.

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