(Updates with Raskin comment in 14th paragraph.)
Sept. 26 (Bloomberg) -- St. Louis Federal Reserve President James Bullard said the long-term rate of U.S. economic expansion may be lower than anticipated in part because the house price bubble last decade created unrealistic expectations for growth.
“It is not reasonable to expect the economy to climb rapidly back to the 2007, Q4 peak since part of that peak was due to artificial growth driven by bubble behavior,” Bullard said today in New York. “A more reasonable interpretation is that fundamental potential growth in the U.S. has been somewhat lower than previously thought.”
Fed policy makers are trying to ascertain why economic growth has fallen short of their expectations during the past two years following the end of the deepest recession since the 1930s. Growth averaged less than 1 percent in the first half of this year, and Wall Street economists have raised their odds for the possibility of another recession.
The Fed’s “asset purchase program clearly drove both inflation and inflation expectations higher and closer to the Committee’s implicit target over the last year,” Bullard said to an event hosted by Medley Global Advisors and the Financial Times. Given that actual real economic performance was weaker, “this should have meant less inflation, not more,” he said.
The gap between long-run U.S. growth and the potential growth, sometimes called the “output gap,” may be “considerably smaller than previously thought,” Bullard said. In addition, “the output gap has considerably less influence on inflation than commonly thought,” he said.
Concerns Over Capital
During a question period with the audience, Bullard said he had confidence in European banks amid concerns over their capital.
“I don’t think it’s reasonable” to think Europe would abandon its banks, he said. “The Europeans are fully committed to backing their banks.”
Europe’s political process in handling the debt crisis has been “slow moving” and that “is not going to change,” Bullard said.
Bullard also said tolerance for accelerating price gains isn’t the way to revive U.S. housing. “I don’t think high inflation is a very good solution to this problem,” he said.
Policy makers voted Sept. 21 to extend the average maturities of the Treasuries in the Fed’s portfolio by purchasing $400 billion of long-term debt while selling an equal amount of shorter-term securities. The operation is an attempt to push down mortgage and other loan rates to spur growth.
Stocks fell for two days last week as investors weren’t persuaded the so-called Operation Twist, similar to an action in 1961, would help to lift growth. Chairman Ben S. Bernanke and his policy-making colleagues also cited “significant downside risks” to the outlook.
“Monetary policy is ultra loose right now, and appropriately so,” Bullard said in response to an audience question.
Fed Governor Sarah Bloom Raskin also voiced support for current policy, saying the weaker-than-anticipated boost to U.S. growth and employment from record stimulus shouldn’t discourage the central bank from further easing.
While the effects of Fed actions have been “somewhat more muted than I might have expected,” that shouldn’t imply that additional easing “would be unhelpful,” Raskin today in a speech in Washington. “Indeed, the opposite conclusion might well be the case -- namely, that additional policy accommodation is warranted under present circumstances.”
U.S. stocks rose, with the Standard & Poor’s 500 Index increasing 1 percent to 1,148.09 at 12:05 p.m. in New York trading. Yields on 10-year Treasury notes rose seven basis points, or 0.07 percentage point, to 1.9 percent.
Bullard reiterated that he favored a “meeting-by-meeting approach” to setting the size of asset purchases so a program’s size responds to changes in the economy. The policy committee could change the date of the planned first interest rate hike from mid-2013 as a “communications tool,” he said.
Bullard, 50, doesn’t vote on monetary policy this year. He joined the St. Louis Fed’s research department in 1990 and became president of the regional bank in 2008.
Economists have cut their forecasts for growth, according to a Bloomberg News survey taken from Sept. 2 to Sept. 7. The median forecast calls for a 1.8 percent annual pace of expansion in the third quarter, down from 2.1 percent in the previous month’s survey. Growth next year is forecast to average 2.2 percent, down from 2.4 percent.
Stagnant payrolls in August have added to data over the past month showing the economy is faltering, including slowing manufacturing, plunging consumer confidence, falling home values and lower bond yields and stock prices.
The Fed maintained its pledge made in August to hold its benchmark interest rate near zero through the middle of 2013 so long as unemployment stays high and the inflation outlook is “subdued.” The target rate has been in a range of zero to 0.25 percent since December 2008.
--Editors: James Tyson, Chris Wellisz
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