Fed Should Tighten Rates Sooner Rather Than Later, Hoenig Says

By Steve Matthews

Oct. 7 (Bloomberg) -- Federal Reserve Bank of Kansas City President Thomas Hoenig said the central bank should start raising interest rates “sooner rather than later,” and such tightening wouldn’t derail the U.S. economic recovery.

“Even if we were to start immediately, much time would pass before incremental increases could be considered tight or even neutral policy,” Hoenig said yesterday in a speech in Denver. “I would not support a tight monetary policy in the current environment, but my experience tells me that we will need to remove our very accommodative policy sooner rather than later.”

Hoenig’s comments parallel those by Fed Governor Kevin Warsh, who said on Sept. 25 the Fed may need to tighten “with greater force than is customary,” and Richmond Fed President Jeffrey Lacker, who said on Oct. 1 that rates may need to be raised even with unemployment near 10 percent.

“We all know that the neutral rate is not zero,” said Hoenig, who doesn’t vote on monetary policy this year. “Equally obvious to me is that a rate of 1 or 2 percent is not tight monetary policy. It is still very accommodative.”

In contrast, New York Fed President William Dudley said this week the central bank needs to focus in the near term on keeping rates low, citing concern inflation could slow too much.

The Federal Open Market Committee said last month the U.S. economy has “picked up” following the deepest recession since the 1930s. Officials slowed the purchase of $1.45 trillion in mortgage-backed securities and housing debt, while pledging to keep the benchmark interest rate near zero for an “extended period.”

Economy Shrank

Economic growth will average 2.6 percent in the second half of this year, according to a Bloomberg News survey of economists last month. The world’s largest economy shrank at a 0.7 percent annual rate from April through June, the best performance in more than a year, according to government figures.

The U.S. jobless rate climbed to 9.8 percent in September, from 9.7 percent in August, the Labor Department reported on Oct. 2. That brings total jobs lost since the recession began in December 2007 to 7.2 million, the most since the Great Depression.

“We are in recovery,” Hoenig said at a forum hosted by the bank’s Denver branch. Stimulus to the economy will probably “prevent a double-dip recession.”

“Consumer confidence is rebounding, and we are starting to see improvement in business and manufacturing,” he said. “Additionally, yield spreads between low-risk assets, such as Treasuries, and higher risk assets are narrowing.”

Almost Zero

The Fed lowered its main interest rate almost to zero in December, switching to asset purchases and credit programs as the main policy tools. Chairman Ben S. Bernanke is leading plans to buy $1.25 trillion of mortgage-backed securities and as much as $200 billion of federal agency debt by March, along with $300 billion of long-term Treasuries by October.

Hoenig also called for Congress to address the problem of creating a resolution mechanism for banks that are so large they could, in the event of failure, damage the financial system. A proposal before Congress for a regulatory overhaul is inadequate, he said.

“The proposal does not adequately address the too-big-to- fail problem in that it still provides too much latitude to rescue failing firms,” he said. “It confirms the practice of addressing failure of the largest firms in an ad hoc manner with individuals rather than the rule of law deciding which firms get rescued and which do not.”

Rescue Firms

Hoenig, the Kansas City Fed’s president since 1991 and the longest-serving Fed policy maker, said large U.S. banks have carried lower capital ratios than their smaller rivals because investors assumed the government will rescue big financial institutions that fail.

“My view is that we do not have to subsidize or ‘learn to live with’ the financial oligarchy that exists,” he said in his speech.

“You can’t keep them from failing,” Hoenig said in response to an audience question. “The unintended consequences of this are just devastating.”

To contact the reporter on this story: Steve Matthews in Mobile at smatthews@bloomberg.net