Fed Official- Low Rates a 'Dangerous Gamble'

Keeping interest rates at record lows is a "dangerous gamble" that could hurt the economy later on by unleashing inflation or new speculative bubbles, a Federal Reserve official said Friday.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, made the comments just days after dissenting with the Fed's decision to take an unconventional step to strengthen the fragile recovery by buying government debt.  Hoenig did say the economy still needs the support of ultra-low rates now. Interest rates have been at record lows near zero for nearly two years.  But he worries that keeping rates too low for too long could create problems later on. For instance, low rates could spur bubbles in the prices of commodities, bonds or other asset prices. Or, they could encourage people and businesses to take on too much debt again and overly leverage themselves, he suggested.  "If we again leave rates too low, too long out of our uneasiness over the strength of the recovery and our intense desire to avoid recession at all costs, we are risking a repeat of past errors and the consequences they bring," Hoenig said in a speech in Lincoln, Neb.

Critics like Hoenig blame the Fed for keeping rates low for too long a period after the 2001 recession. Those low rates fed a housing bubble that eventually burst, and plunged the economy into a severe recession in late 2007, they say.  "I believe that zero rates during a period of modest growth are a dangerous gamble," Hoenig said.

James Bullard, president of the Federal Reserve Bank of St. Louis, is concerned that the weak recovery could push the United States into a deflationary period, like the "lost decade" Japan suffered through in the 1990s. Low rates help combat deflation, a widespread and prolonged drop in prices of goods and services, values of stocks and homes, and in wages.  Hoenig, however, said he sees "no evidence that deflation is the most serious threat to the recovery today."

Nonetheless, the economy's growth slowed sharply in the spring, and unemployment -- now at 9.5% -- has stayed high all year.  Low interest rates cannot solve every problem faced by the United States, he argued.  "In trying to use policy as a cure-all, we will repeat the cycle of severe recession and unemployment in a few short years by keeping rates too low for too long," Hoenig, said. "I wish free money was really free and that there was a painless way to move from severe recession and high leverage to robust and sustainable economic growth, but there is no short cut."