MENLO PARK, Calif., May 29 (Reuters) - A top Federal Reserve official on Thursday called for the U.S. central bank to raise interest rates soon after it winds down its bond-buying stimulus and to raise them more sharply than most of her fellow policymakers expect.
The Fed is on target to phase out bond-buying completely by this coming fall. Fed Chair Janet Yellen has said short-term interest rates will stay at their current near-zero level for a “considerable” time afterward, and will then rise only gradually.
Kansas City Fed President Esther George, among the most hawkish of Fed policymakers, staked out a dissenting view in remarks prepared for delivery to a group of prominent economists and fellow policymakers.
“I would like to see short-term interest rates move higher in response to improving economic conditions shortly after completion of the ‘taper,'” said George, who does not have a vote at the Fed’s policymaking table this year but does participate in the discussions.
Keeping rates low for as long as the Fed has, since December 2008, gives banks the incentive to take risks that could threaten financial stability, she said. Continuing to keep them low until even after the recovery is complete courts greater risk-taking than is necessary, she said.
Fed officials on average forecast short-term rates to be at just 2.25 percent by the end of 2016, well below the 4 percent level that is the historical norm.
“The degree of inertia suggested (by that forecast) goes beyond what is required to achieve a smooth exit” from the Fed’s near-zero rate regime, she said. “In my view, it will likely be appropriate to raise the federal funds rate at a somewhat faster pace.”
When to raise rates is at the center of the current policy debate at the Fed, which next meets in mid-June. Fed officials have increasingly signaled they are sympathetic to the view that low rates may threaten financial stability by fostering bubbles.
George said that while she believes supervisory and regulatory efforts to keep bank risk-taking in check are important, “I think monetary policymakers also need to maintain a careful eye on the financial system and how interest rate policy affects incentives for financial markets and institutions.”
Once the Fed starts raising rates, financial markets could become much more volatility, she predicted. But the Fed, she said, must stick to its guns.
“In this environment, the pressure to quickly back away from a rising rate policy will be significant; such pressures will need to be resisted,” she said. “If not, we risk moving into a confusing stop-and-go policy environment.” (Reporting by Ann Saphir; Editing by Lisa Shumaker)