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Fed's new zero-rate vow has Kaplan worried on market excesses

FILE PHOTO: Dallas Federal Reserve Bank President Robert Kaplan gestures during a news conference after of the True Economic Talks event in Mexico City, Mexico, July 14, 2017. REUTERS/Edgard Garrido/File Photo

(Reuters) - U.S. Dallas Federal Reserve President Robert Kaplan said Monday he is “completely” on board with keeping interest rates at their current near-zero level even into 2023, but worries a vow to keep them there even longer risks excesses and imbalances in financial markets.

Last week the Fed promised not to raise rates until the economy reaches full employment and inflation is on track to moderately exceed the Fed’s 2% target.

Kaplan, who dissented, said Monday he believes the economy will be on track for full employment and stable prices by late 2022 or into 2023.

“I’m a big believer if you make a commitment like this, you need to fulfill it, unless there’s an extraordinary reason why you can’t,” Kaplan told Reuters in a phone interview. “My worry was that this would encourage in the shorter run more risk- taking and maybe create imbalances and instabilities.”

Because technological advances and other forces are putting downward pressure on inflation, promising to delay rate hikes until inflation is headed above 2% could lock the central bank into inaction in the face of such imbalances.

And if inflation does unexpectedly take off before the labor market has fully healed, the new vow could make it hard for the Fed to react, he said.

Kaplan said he expects that as the economy recovers, the neutral rate - the theoretical level of interest rates at which a healthy economy can chug along - will rise. As that happens, he said, “if you keep your setting of the fed funds rate exactly where it is, you are actually increasing the level of accommodation.”

Kaplan said he now expects unemployment to fall to as low as 7.25% this year, and for the economy to shrink less than 3%, far less than his earlier forecasts.

If the economy is approaching 3.5% unemployment, where it was before the coronavirus crisis, but inflation is still a little below 2%, “I certainly understand why you’d want to maintain a high level of accommodation, but do you actually want to be increasing the level of accommodation? I don’t know if you do or don’t, and that’s the point.”

Reporting by Ann Saphir; Editing by Andrea Ricci

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