Fed official reveals doubts

Flaws cited in new stimulus

Kevin Warsh said he doubts the Fed’s plan will have “durable benefits.’’ Kevin Warsh said he doubts the Fed’s plan will have “durable benefits.’’ (Jin Lee/ Bloomberg News)
By Jeannine Aversa
Associated Press / November 9, 2010

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WASHINGTON — A Federal Reserve official with close ties to chairman Ben Bernanke expressed doubts yesterday about whether the Fed’s new $600 billion bond-purchase program would succeed in boosting the economy.

Kevin Warsh, a Fed governor, also warned of “significant risks’’ associated with the program, including the potential for triggering excessive inflation later on.

The Fed’s program, announced last week, is intended to push interest rates on loans even lower than they are now. The Fed hopes cheaper loans will spur Americans to borrow and spend more. A stronger economy could, in turn, prompt companies to hire more and invigorate the economy.

But Warsh said he doubted the program will have “significant’’ or “durable benefits’’ for the economy. He made the comments in a speech to the annual meeting of the Securities Industry and Financial Markets Association in New York.

Despite his reservations, Warsh was among 10 Fed officials who voted for the $600 billion program. The sole dissent came from Thomas Hoenig, president of the Federal Reserve Bank of Kansas City.

Warsh’s comments point to the uneasiness about the risks the central bank is taking with the new program — even among some Fed officials who supported it. Warsh, a Bernanke lieutenant, has never dissented from a Fed vote.

Warsh warned that the Fed might have to reconsider its program if the dollar continues to fall or if commodity prices continue to rise, raising inflation across the economy.

The Fed last week said it will monitor the effect of the bond-buying program on the economy. It left the door open to scaling back the purchases if the economy grows more than expected or if high inflation becomes too much of a threat. On the other hand, the Fed indicated it would boost its purchases if economic conditions weakened.

“The Federal Reserve is not a repair shop for broken fiscal, trade, or regulatory policies,’’ Warsh said. “Given what ails us, additional monetary policy measures are, at best, poor substitutes for more powerful pro-growth policies.’’

Warsh suggested that Congress reform the tax code to provide more incentives for businesses to step up investment. He indicated that such an approach is a more effective way to strengthen the economy.

Taking a different stance, James Bullard, president of the Federal Reserve Bank of St. Louis, argued in a speech yesterday in New York that the “benefits outweigh the risks.’’ He also voted for the $600 billion program last week.

Bullard said he worries that the weak economy might lead to deflation — a destructive drop in the prices of goods and services, wages, and in the values of homes and stocks.

The Fed’s bond-buying program should help prevent any deflationary forces from taking hold, he said. Bullard did acknowledge that the program risks spurring too-high inflation.

With the Fed’s efforts to stimulate growth, its balance sheet now stands at $2.3 trillion. Adding the new bond holdings will push it to nearly $3 trillion.