UPDATE 1-Fed's Stein backs QE3, says policy remains effective

Fri Nov 30, 2012 10:14pm GMT

(Adds comments from speech, background on economy and Fed policy)

By Jonathan Spicer

BOSTON Nov 30 (Reuters) - The Federal Reserve should continue buying long-term bonds to support economic growth until the outlook for U.S. employment gets considerably better, Fed Board Governor Jeremy Stein said on Friday.

Stein, a Harvard finance professor who joined the Fed in May, defended the effectiveness of the unconventional monetary policies the U.S. central bank has undertaken since the financial crisis and deep recession.

Indeed, he argued they have not only brought down rates on long-term government bonds, but also have made it cheaper for corporations to borrow in capital markets.

"While this is not entirely uncontroversial, my own reading of the evidence is that there has also been substantial pass-through to corporate bond rates," Stein said at a conference in Boston.

He estimated that an additional $500 billion on Treasury purchases would lower long-term bond rates both in the government and corporate markets by around 0.15-0.20 percentage point.

Stein admitted that the impact of purchasing assets tends to diminish over time because, in a weak economic environment, companies opt to lower their funding costs by refinancing rather than make new investments.

Still, he argued that the Fed's strategy of buying mortgage-backed securities was particularly effective in helping the housing finance sector. In September, the Fed launched a new, open-ended stimulus plan, starting with the purchase of $40 billion per month in mortgage-backed securities.

"I suspect that mortgage purchases may confer more macroeconomic stimulus dollar-for-dollar than Treasury purchases," Stein said.

The U.S. economy expanded 2.7 percent in the third quarter, but growth is expected to come in at a significantly slower rate for the last three months of the year. Consumer spending posted its first drop in five months during October, according to a report on Friday. (Writing by Pedro Nicolaci da Costa; Editing by Leslie Adler)