The Federal Reserve is worried about the U.S. economy's health and is looking at ways to offer more monetary stimulus, the central bank's influential vice chair, Janet Yellen, said.
"We are prepared to employ our tools as appropriate to foster a stronger economic recovery in a context of price stability," Yellen told a financial industry conference Friday.
Her comments come just a day after a call by another Fed board governor, Daniel Tarullo, for the central bank to consider a fresh round of mortgage bond purchases.
Yellen said the central bank was exploring many options for easing monetary policy, and did not endorse any particular route.
She said bond markets were again hinting at a rising risk of deflation — the threat that prompted the Fed's second round of bond buys last year.
She also argued that Europe's financial crisis threatened to spill over into the United States, possibly by forcing anxious banks to tighten credit at a time when the economic rebound remains tenuous.
"The potential for such adverse financial developments to derail the recovery creates, in my view, significant downside risks to the outlook," Yellen said.
U.S. economic growth has been disappointing, averaging less than a 1 percent pace in the first half of the year despite the Fed's unprecedented support for the economy, including near zero interest rates and more than $2 trillion in asset purchases. The jobless rate has been stuck above 9 percent for several months, prompting fears of another downturn.
In a further sign that Fed is actively considering action, Minneapolis Federal Reserve Bank President Narayana Kocherlakota, who opposed a recent monetary easing drive, said on Friday he liked one idea offered by a leading Fed dove, if not the specifics.
Chicago Fed chief Charles Evans has said the Fed should specify the levels of unemployment and inflation that would force it to move away from its ultra easy policy stand.
"I like his framing of the problem very much," Kocherlakota told reporters after a speech here. "But actually getting to the quantities, I'd have to think about it more."
Evans has suggested keeping rates low until unemployment fell to 7 percent, as long as inflation stayed below 3 percent. The Fed's informal target for inflation is 2 percent.
Given the wide range of proposals being floated, analysts are beginning to wonder whether the Fed will not simply choose to hold pat at its upcoming meeting on Nov. 1-2.
Yellen acknowledged that the Fed was taking a look at Evans' proposal, but noted that it had some pitfalls, including the potential that investors and the public might misinterpret the numerical guideposts.
"Such thresholds could potentially be misunderstood as conveying the (Fed's) longer-run objectives rather than the conditions surrounding the likely onset of policy firming," she said.
Another Fed dissenter, the Dallas Fed's Richard Fisher, opposed Tarullo's suggestion of further mortgage bond buys. "I am not similarly inclined," he told reporters.
Fisher and other Fed hawks worry that the central bank's expanded balance sheet sows the seeds to future inflation. But Yellen argued that the notion that an expansion in bank reserves was automatically inflationary was "erroneous."
Indeed, Yellen argued inflation is not an immediate concern, saying that if anything there were risks that disinflationary forces might gather pace.
She urged lawmakers not to tighten the U.S. budget too quickly, since this could also risk derailing the expansion.
Many economists still see a significant risk that the United States will slip back into recession in comings months.
Large-scale bond-buying by the Fed has proven a controversial practice.
Richmond Fed President Jeffrey Lacker earlier this week reiterated his view that mortgage bond purchases in particular were not appropriate for the central bank, since in his view they represent a form of credit allocation.
Yellen suggested the Fed is not ruling out the option of further bond purchases, although she did not address the proposal to consider buying more mortgage bonds. She also indicated any additional bond purchases might include securities other than the long-term government bonds on which the central bank has recently concentrated.
"Purchasing a very large proportion of the outstanding stock of longer-term Treasury securities could potentially have adverse effects on market functioning," she said. "Thus, securities purchases across a wide spectrum of maturities might become more appropriate if evolving economic conditions called for significantly greater monetary accommodation."
In September, the Fed announced a plan to sell $400 billion in short-term Treasurys to buy longer-dated ones, an attempt to keep long-term borrowing costs as low as possible.
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