Fed May Need Aggression in Reversing Actions, Warsh Says in WSJ

By Scott Lanman

Sept. 25 (Bloomberg) -- Federal Reserve Governor Kevin Warsh said the U.S. central bank may need to be as aggressive in reversing its actions to revive the economy and financial markets as policy makers were in starting them.

“If ‘whatever it takes’ was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Federal Reserve’s institutional credibility,” Warsh said in an opinion piece published late yesterday on the Wall Street Journal’s Web site.

The message from Warsh, 39, one of Chairman Ben S. Bernanke’s top advisers during the financial crisis, stresses that the Fed may start to raise interest rates before it’s obvious that it is necessary. Just two days ago, the Fed unanimously decided to keep its benchmark rate near zero and repeat that rates will stay low for an “extended period.”

“Market participants and policy makers alike should steer clear of ironclad policy prescriptions,” Warsh said. “Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities.”

The Fed has already begun cutting back some of its emergency aid to financial firms as part of its so-called exit strategy from a $1 trillion credit expansion.

‘Extended Period’

The central bank said yesterday it will further shrink auctions of cash loans to banks and Treasury securities to bond dealers, reducing the combined initiatives to $100 billion by January from $450 billion. The Fed cited “continued improvements” in financial markets.

In the Journal piece, Warsh repeated parts of the Federal Open Market Committee’s Sept. 23 statement, which he supported. “Economic activity has picked up, and conditions in financial markets have improved further,” Warsh said. “Longer-term inflation expectations are stable, and economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

Warsh is scheduled to speak to a Chicago Fed-hosted banking conference today, where he will deliver a similar message.

A former Morgan Stanley investment banker appointed to the Fed in 2006 by then-President George W. Bush, Warsh helped Bernanke and the Treasury navigate the financial crisis, including developing terms of the government’s purchases of bank stakes and mediating a takeover fight over Wachovia Corp.

Depths of ‘Panic’

“Judgments made by policy makers in the current period are likely to be as consequential as any made in the depths of the panic,” Warsh said in the Journal. “That means policy makers should continue to communicate as clearly as possible the guideposts, conditions and means by which extraordinary monetary accommodation will be unwound, including the removal of excess bank reserves.”

Bernanke communicated the means in July congressional testimony and a related op-ed piece, also published in the Wall Street Journal. The Fed chief outlined tools for raising interest rates and mopping up bank reserves, saying officials will use the interest rate on banks’ deposits with the central bank as a principal way to prevent a surge of money growth.

Warsh said he’s confident the Fed will tighten credit in a “timely” way, providing the “ultimate rejoinder to our critics,” who he didn’t identify.

One critic has been Allan Meltzer, a Fed historian and economist at Carnegie Mellon University in Pittsburgh. He said earlier this year the central bank has often lacked the resolve to pursue unpopular policies to keep prices in check.

Reverse Actions

Warsh aimed to address such concerns in his op-ed piece, saying moving too slowly to reverse the Fed’s actions “ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.”

At the same time, making the mistake of moving too fast or too slow to tighten credit is “neither uncommon nor unexpected in the normal conduct of monetary policy,” he said. Given that, “a nimble, even-handed approach toward our risk-management challenges will prove necessary,” he said.

Developments in financial markets, such as asset prices and related interest rates, “bear especially careful watching,” Warsh said. “They may impart more forward-looking signs of growth and inflation prospects than arithmetic readings of stimulus-induced gross domestic product or lagged composite readings of inflation,” he said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.