President Narayana Kocherlakota of the Minneapolis Federal Reserve Bank said the central bank's low interest-rate policies, though necessary, will probably generate signs of financial instability.
"Unusually low real interest rates should be expected to be linked with inflated asset prices, high asset return volatility and heightened merger activity," Kocherlakota said last week in the prepared text of a speech in New York. "All of these financial market outcomes are often interpreted as signifying financial market instability."
He told reporters later that he doesn't see financial instability as imminent.
Fed Governor Jeremy Stein and Kansas City Fed President Esther George are among those who have voiced concerns that an extended period of low interest rates is heightening the risk of asset bubbles in markets such as junk bonds and farmland.
While George has dissented from this year's Federal Open Market Committee (FOMC) decisions because of this risk, Kocherlakota is among the strongest supporters of additional monetary stimulus on the committee.
In speeches earlier this month, Kocherlakota said he foresees an "ongoing modest recovery" with unemployment staying at 7 percent or more through 2014. The slow recovery calls for "more accommodation," he said, repeating his call to postpone any increase in interest rates. He doesn't vote on policy this year.
"It is likely that, for a number of years to come, the FOMC will only achieve its dual mandate of maximum employment and price stability if it keeps real interest rates unusually low," Kocherlakota said.
The Minneapolis Fed chief has said the central bank should hold its target interest rate near zero until unemployment falls to 5.5 percent. That's a percentage point below the 6.5 percent threshold the FOMC has adopted.
Answering audience questions after a speech, Kocherlakota said the recovery in the housing market is evidence that the Fed's monthly purchases of $85 billion in Treasuries and mortgage securities are effective.
"It would be nice if we did even more along those lines because I think our tools have been effective," he said. "In the housing market, in particular, you've certainly seen direct effects of that kind of stimulus."
Kocherlakota told reporters that the growth outlook is sufficient to raise inflation, currently measured at 1.3 percent by the Fed's preferred price gauge, closer to the Fed's goal of 2 percent.
"Given the stimulus we're providing, given the growth I see in the economy, 2.5 percent in 2013, 3 percent in 2014, that kind of growth I see as sufficient to put upward pressure on inflation," Kocherlakota said.
He said he's already "in favor of more accommodation" and further declines in the inflation rate would make him "even more" supportive of additional stimulus.
Kocherlakota said that "for a considerable period of time," the FOMC may only be able to "achieve its macroeconomic objectives in association with signs of instability in financial markets. ... In my view, these potentialities are best addressed using effective supervision and regulation of the financial sector."
