Fed officials signal next policy battle: rate guidance


By Jonathan Spicer and Jason Lange

ROGERS, Ark./ASHEBORO, NC, Nov 21 (Reuters) - As the FederalReserve nears a decision to pare its bond-buying program, toppolicymakers on Thursday turned to a new monetary policybattlefront: a growing debate over how the Fed should signal thetiming of eventual interest rate hikes.

Top Fed officials at opposite ends of the policy spectrumstill disagree on the optimal future for the Fed's$85-billion-a-month bond-buying program.

The president of the St. Louis Federal Reserve Bank, JamesBullard, on Thursday said accommodative bond-buying shouldcontinue because there are no signs of price rises so far, whileRichmond Fed President Jeffrey Lacker at a separate eventreiterated his opposition on grounds the program is ineffective.

But minutes from the Fed's last policy meeting suggestofficials are preparing to reduce the pace of bond-buying incoming months as long as the economy continues to improve.

When they do, the policy debate may shift to "forwardguidance": the language the Fed uses to tell markets how long itwill keep short-term rates near zero, where they've been fornearly five years.

Already, policymakers are talking about it, and signs pointto more muscular language around rate guidance, rather thanadding numerical thresholds or adjusting current ones.

The Fed has promised to hold rates near zero untilunemployment hits 6.5 percent, provided the outlook forinflation stays under 2.5 percent.

Bullard has long been an advocate of adding an inflationfloor to assure markets that the Fed will not raise rates ifinflation continues to linger at a level that is too low forcomfort.

Inflation is running at just over 1 percent, about half theFed's 2 percent target.

But on Thursday Bullard signaled his willingness to back adifferent option, "to not change the forward guidance at all butto describe how we will behave after we pass the 6.5 pctthreshold.

"The chairman has done this, other members of the committeehave done this," Bullard said. "That's maybe the simplest thingto do and possibly that will be the limits of what we could dowith this forward guidance but we'll see."

Fed Chairman Ben Bernanke earlier this week said the U.S.central bank could be patient before raising rates, saying thepolicy target is likely to stay near zero "perhaps well after"unemployment falls below 6.5 percent.

In October, the rate was 7.3 percent.

Lacker for his part was less enthusiastic, saying the Fedshould be cautious about making any changes to its pledges tokeep interest rates low.

"If you go changing what you're saying about how you'relikely to behave from time to time, you could erode people'sconfidence that you're going to follow through on what you sayyou're going to do," Lacker told reporters. "We ought to bereally cautious about tweaking the forward guidance apparatus."


Bond-buying in the wake of the 2007-2009 recession hasswelled the Fed's balance sheet to about $3.9 trillion. While itis meant to spur investment, hiring and economic growth, thereare concerns that the money-printing is laying grounds for arun-up in inflation.

Bullard said such concerns should not keep the Fed fromcontinuing its bond purchases.

"What we need to do is continue with the program for now aswe have, but if an inflation problem starts to develop we haveto be willing to move to arrest that problem," Bullard told aUniversity of Arkansas event. "At that point I'd put on myinflation hawk hat and spring into action.

"We do want to get back to a normal-sized balance sheet," hesaid, adding the portfolio should consist of only U.S. Treasurybonds.

To Lacker, who has never taken off his inflation hawk hat, price gains are liable to accelerate.

"My sense is that inflation will move back toward 2 percentover the next year or two, in part because measures of expectedinflation remain well contained," Lacker said. "This is not acertainty, however, and I believe the (Fed) will want to watchthis closely."

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