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Fed official: Stop asset buying, raise interest rates

By Annalyn Censky, staff reporter


DENVER (CNNMoney.com) -- Wall Street is counting on the Federal Reserve to announce another round of asset purchases next month. But not everyone on the Fed is in favor of that policy.

Speaking to a room full of economists in Denver, Kansas City Fed President Thomas Hoenig laid out several reasons for his opposition to the monetary policy known as quantitative easing, or buying up Treasurys as a way to push interest rates lower and stimulate more spending.

While the first round of quantitative easing in 2008 was effective, purchasing additional assets now wouldn't work, Hoenig said at the conference of the National Association of Business Economics, Tuesday.

"While [a second round of quantitative easing] might work in clean theoretical models, I am less confident it will work in the real world," Hoenig said.

The long-term costs of that policy would outweigh its short-term benefits by expanding the Fed's balance sheet to an unmanageable amount and increasing the risk of inflation, he said.

"Without clear terms and goals, quantitative easing becomes an open-ended commitment that leads to maintaining the funds rate too low and the Federal Reserve's balance sheet too large," he said. "The result is a further misallocation of resources, more imbalances and more volatility."

Since September 2008, the Fed has pumped some $2 trillion into the economy through asset purchases, which have since wound down.

But when the Fed emerged from its policy-making meeting in September with a bearish outlook, it dropped hints that led Wall Street to think more purchases are forthcoming, to the tune of $500 billion or more.

Amid all the excitement about so-called "QE2", Hoenig has been the lone contrarian among the Fed's voting members, warning of asset bubbles since early this year, and consistently voting against additional asset purchases and low interest rates.

Quantitative easing worked in the fall of 2008 because financial markets were in a crisis, he said, but now that the crisis has passed, such a policy would have a minor effect at best on economic activity.

"Right now the economy and banking system are awash in liquidity with trillions of dollars lying idle or searching for places to be deployed," he said.

Dumping another trillion dollars into the system is not likely to change the fact that businesses and consumers are opting to pay down debt and save up, rather than increase their spending, he said.

Instead, Hoenig suggested the Fed start to "normalize" its monetary policy, by gradually backing away from asset purchases and raising interest rates slightly from their near-zero levels.

"We need to go back to a more normal monetary policy, but we need to do it very carefully"

Keeping interest rates too low for too long, he said, risks causing new asset bubbles to form, which could ultimately lead the nation into another financial crisis.

"While I can't predict bubbles, I do know the conditions that are at least agreeable with bubbles. And that's the risk we take."

Hoenig's remarks follow a speech by newly appointed Fed vice chairwoman Janet Yellen on Monday at the same conference. While Yellen is considered to have a more dovish outlook on inflation, she also acknowledged keeping rates too low for too long, could lead to asset bubbles.  To top of page

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