Poor fiscal policy, politics a hindrance: central bankers


By Dave Graham and Michael O'Boyle

MEXICO CITY, Oct 15 (Reuters) - Fiscal policy and politicsrisk undermining central bankers' efforts to revive the globaleconomy, top central bank officials warned on Tuesday, as apotentially devastating debt default loomed in the UnitedStates.

Washington is locked in a bitter budget battle that haspartially shut down the federal government. The U.S. FederalReserve has repeatedly warned the impasse creates seriousheadwinds for growth and hiring and could inflict anotherrecession if it triggers a U.S. default.

While there was progress in talks, a deal was still far off,the White House said.

New York Fed President William Dudley told a panel in MexicoCity that massive bond buying by the U.S. central bank mightpotentially undermine its independence if this led to losses onits balance sheet when interest rates rise.

"While the threat is low, central bankers need to becognizant of such risks, and clearly explain the motivations fortheir actions in order to mitigate such risks," he said inremarks prepared for a conference hosted by the Bank of Mexico.

"A far more important threat to central bank independencethan the use of unconventional monetary policy is whether thefiscal authorities act in a manner consistent with the centralbank's objectives," he told participants at the event, onunconventional monetary policy and central bank independence.

Europe is also feeling pressure, with governments losing alot of sovereignty to financial markets, European Central Bank(ECB) governing council member Klaas Knot said, adding it wasimperative to protect central bank independence.

"Central banks' balance sheets are becoming more and moreexposed to economic risk and political pressure," Knot told theconference.

"Eventually, this may result in a substantial amount ofnegative capital in a central bank's balance sheet. This isundesirable because it could undermine a central bank'scredibility," he added.

U.S. senators voiced hope that a bipartisan deal couldemerge on Tuesday to end Washington's fiscal crisis even asRepublicans in the House of Representatives proposed their ownplan which the White House dismissed.

Even if Democrats and Republicans agree, it could beWednesday before the U.S. Senate signs off on a plan, senatorssaid, close to a Thursday deadline when the Obama administrationsays it will reach its borrowing limit and risk default.

Some were hopeful at the prospect of a deal.

"It is very good news for all the markets, for the UnitedStates and for emerging markets," said Manuel Sanchez, one ofthe Mexican central bank's deputy governors.


The Fed has been harshly criticized by some Republicanlawmakers for an unprecedented 5 years of ultra-easy monetarypolicy, after it slashed interest rates near to zero in late2008 and quadrupled its balance sheet to around $3.7 trillionvia bond purchases aimed at holding down borrowing costs.

Dudley said the Fed might suffer losses on these holdings dueto a rise in interest rates, which could reduce, or even wipeout, the amount it pays back to U.S. taxpayers every year.

This might expose it to political pressure if the loss forcedit to ask Congress for more money. But Dudley said that problemcould be avoided by an accounting technique - creating a"deferred asset" on its balance sheet - which would preserve itsbudgetary independence.

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