MNI INTERVIEW: Hoenig: Fed's Easy Money Trap Adds Market Risk

--Ex-Kansas Fed President Sees Steady Rates This Year

By Pedro Nicolaci da Costa

     WASHINGTON (MNI) - The Federal Reserve won't be able to reverse ultra-easy

monetary policies for at least a decade, adding risk to the financial system,

former Kansas City Fed President Thomas Hoenig told MNI.

     The Fed is getting stuck in a world of ample bank reserves and extensive

bond purchases in a financial system already characterized by excess leverage,

Hoenig said in an interview. Hoenig also saw little chance the Fed will move its

policy rate this year. 

     "Now QE is the policy tool -- they're trapped and I don't see how they're

getting out of it anytime soon," he said. "It will take at least a decade if not

more" to reverse those policies, he said.

     The Fed halted efforts to reduce its balance sheet in September after a

repo market squeeze and switched to an ample reserves policy. The balance sheet

has expanded nearly half a trillion dollars in the last few months and equity

prices have soared to new highs. Investors have questioned whether the policy is

an indirect form of QE and the Fed has laid out no clear plan to move out of the

the kind of "trap" Hoenig is worried about. 

     "The dust-up with the repo market kind of demonstrated that," policy

dilemma, Hoenig said.

     --FED ON HOLD

     The Fed's balance sheet is USD4.2 trillion compared with less than USD1

trillion before the last downturn. Some Fed officials have argued the economy's

growth over the last decade justifies much of the growth in the balance sheet. 

     Hoenig, also former vice chair of the Federal Deposit Insurance

Corporation, said the Fed may have made an earlier policy miscalculation by

underestimating the tightening impact of a shrinking balance sheet and higher

official borrowing costs.

     Forced to reverse course and cut rates three times last year, the Fed now

intends to stand pat if at all possible, a path Hoenig views as wise.

     "They certainly should try to keep rates where they are for now," he said.

"I wouldn't lower them, if they saw a temporary slowdown. If the economy slows

too much they will initiate further quantitative easing."

     The bar for a resumption of interest rate hikes is even higher, Hoenig

said: "I don't think they're going to be raising them until or unless inflation

really breaks out above the 3% to 3.5% mark."

     --INFLATION GOALS

     Inflation is not showing up in consumer prices but Hoenig worries about

asset price inflation. Higher stock and bond prices pose a danger to financial

stability and can boost inequality since those gains flow mostly to the wealthy.

     Another reason the Fed may be stuck with easy money for a long time is

because Hoenig said there will likely be little change from the Fed's framework

review. Policymakers would have begun signaling any major changes to the Fed's

2% inflation target system well ahead of a possible mid-year announcement, he

said.

--MNI Washington Bureau; +1 202 371 2121; email: pedro.dacosta.ext@marketnews.com

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

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