Minneapolis Fed chief sees no need to stop $600B plan

Kocherlakota Sees No Need to Stop Fed's $600 Billion Plan

March 3 (Bloomberg) -- Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said he sees no reason to stop the Fed's $600 billion in Treasury purchases and that it's too soon for the central bank to begin withdrawing record stimulus.

"My inclination is to complete it," he told reporters after a speech today in St. Cloud, Minnesota, referring to the plan to buy bonds through June. "My bar for stopping the second LSAP," or large-scale asset purchases, "would be pretty high, very high."

The regional bank chief voted with the rest of the Federal Open Market Committee at a Jan. 25-26 meeting, pledging to move forward with bond purchases in a so-called quantitative easing program to stimulate growth and reduce unemployment. He holds a vote on monetary policy this year for the first time.

"It's certainly too early to be implementing an exit strategy, but it's not too early to begin thinking about how to formulate that exit strategy," Kocherlakota, 47, said in his first interview with a group of reporters.

The central bank has held the target for the federal funds rate near zero for two years and purchased $1.7 trillion of mortgage debt and Treasuries through March 2010 to pull the U.S. out of a recession. The FOMC voted in November to undertake the second round of purchases.

Changing the Fed's commitment to keep rates low for an "extended period" would be the preferred first step in tightening, Kocherlakota said. After that he would favor that the Fed drain reserves or sell assets, then raise rates, he said, adding he remains "flexible."

'KEY QUESTION

"Once we get to that point, we should be clear about what we do," Kocherlakota said. "But I think the key question is going to be about timing."

The Fed has a "great deal of confidence" in its ability "to implement an exit strategy without having to shrink its balance sheet," he said, adding that he would be "surprised" if in five years the balance sheet is as large as it is now.

The central bank's "highly accommodative" monetary policy is warranted, given a natural rate of unemployment that may be as high as 8.9 percent, Kocherlakota said in his speech.

The labor market improved throughout the U.S. early this year, driven by rising retail sales and "solid growth" in manufacturing, the Fed said yesterday in its Beige Book report.

Labor market conditions "continued to strengthen modestly, with all Districts reporting some degree of improvement," the Fed said in the anecdotal account of the economy released two weeks before meetings of the FOMC. Its last survey, released Jan. 12, said the job market was "firming somewhat."

'CHANGES IN THE GAP'

The FOMC "will need to remain vigilant to the possibility of changes in the gap between the unemployment rate" and natural jobless rate, Kocherlakota, said at the St. Cloud State University Annual Winter Institute. The natural rate of unemployment is the lowest level that can be reached without fueling inflation.

"When that gap is big, we need a lot of accommodation," the central banker said. "I myself will be paying close attention to the behavior of core inflation," or prices excluding food and energy.

U.S. equities rose after jobless claims unexpectedly fell, underscoring the Fed's assessment that the labor market is improving. The Standard & Poor's 500 index rose 1.7 percent to 1,330.97 in New York trading.

Another report released today showed American service industries grew at the fastest pace in five years.

ADDED WORKERS

The jobless rate unexpectedly declined in January to the lowest level in 21 months, dropping to 9 percent from 9.4 percent in December, the Labor Department said last month. Employers added just 36,000 workers.

The U.S. economy grew at a 2.8 percent annual rate in the fourth quarter, slower than previously calculated and less than forecast as state and local governments made deeper cuts in spending. The revised figure for gross domestic product compares with a 3.2 percent earlier estimate and a 2.6 percent gain in the third quarter, Commerce Department figures showed last week.

The Fed's purchases have had "positive, but modest" effects, said Kocherlakota, who has led the Minneapolis Fed since October 2009 and is former chairman of the economics department at the University of Minnesota. He said he could be persuaded to taper the $600 billion in purchases, and that a prolonged period of high oil prices will be a drag on the economy.