Kohn: Fed to raise rates before spending overheats
Federal Reserve Vice Chairman Donald Kohn said on Wednesday policymakers would raise benchmark interest rates well before consumer spending and business investment overheats, adding that obstacles to borrowing are likely to subdue the economic recovery.
“We must begin to withdraw (monetary policy) accommodation well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability,” he said at a monetary policy conference at the Cato Institute.
Kohn said he could not predict how rapidly the Fed would raise rates or withdraw its massive supply of money to the financial system. He said the Fed — the U.S. central bank –would watch carefully how its extraordinary efforts to support the economy are affecting spending decisions and inflation expectations in timing its exit strategy.
The Fed has the necessary tools to pull back its help for the economy, he said. Paying interest on bank reserves is chief among these, he added.
However, the Fed will also need to drain reserves at some point, he said.
The Fed might also consider sales of longer-term assets if it believes that longer-term rates are not responding appropriately to its removal of monetary stimulus, Kohn said.
The Fed has chopped benchmark interbank lending rates to zero and pumped hundreds of billions of dollars into the economy to pull it out of a devastating financial crisis and deep recession.
Policy-makers have in recent weeks noted signs the downturn may have ended, but promised at their most recent meeting to keep rates extremely low for a long time to support the recovery, which they expect to be slowed down by high unemployment.
Kohn renewed the Fed’s cautious assessment of the economic outlook and its low-rate pledge.
“Although economic conditions have apparently begun to improve … continuing restraints on credit are likely to constrain the speed of recovery,” he said.
(Reporting by Mark Felsenthal; Editing by James Dalgleish)