By Ann Saphir
CHICAGO, Oct 18 (Reuters) - The Federal Reserve should be 'extraordinarily careful' about hiking interest rates to head off potential risks to financial stability when more effective tools, like supervision, are available, a top Fed policymaker argued on Friday.
Chicago Fed President Charles Evans said raising rates to tamp down risk-taking, when what the economy needs is support from low interest rates, is a 'poor choice.'
'If more restrictive monetary policies were pursued to generate higher interest rates, they would likely result in higher unemployment and a sharp decline in asset prices, choking the moderate recovery,' Evans told the Financial Management Association's annual meeting. 'Such an adverse economic outcome is unlikely to set a favorable foundation for financial stability.'
In an effort to pull the economy from its worst downturn in decades, the Fed has kept short-term interest rates near zero since December 2008 and is buying $85 billion in Treasuries and housing-backed securities each month to lower long-term borrowing costs as well.
Low rates are aimed at encouraging investment and hiring, and Evans, one of ten current voters on Fed policy this year, has been an ardent supporter of the policies.
On Friday he said that he had been open to paring bond purchases last month, but had been 'persuaded' by his colleagues that it would be better to wait.
Since then, he told reporters, 'I haven't seen anything like what I thought it would take in order to get us to a 'yes' on tapering.'
But some Fed officials are worried about whether easy policies are fueling unseen asset bubbles, and have cited financial stability concerns as one reason the Fed should pare its bond-buying program.
Kansas City Fed President Esther George, who has dissented at every Fed policy-setting meeting this year, has warned that keeping rates too low for too long could fuel excessive risk-taking. Her equally hawkish colleague Dallas Fed President Richard Fisher on Thursday said he was increasingly concerned that low rates were contributing to a nascent housing bubble.
Evans acknowledged that part of the goal of the Fed's easy-money policies is indeed to encourage risk-taking, because in times of a weak economy, people and businesses often go into a defensive crouch. He also said that leaving rates too low for too long can lead to excessive risk-taking among some investors.
But raising rates prematurely is likely to do more damage than good to the economy as a whole, he said.
'We ought to be extraordinarily careful if we are going to use our blunt short-term interest rate tools, figuratively speaking, in order to address that,' he told reporters after the speech.
'Higher interest rates would reduce risk-taking where it is excessive; but they also would result in a pullback in economic activity in sectors where risk-taking might already be overly restrained,' Evans said. 'That's how a blunt tool works.'
The Fed should instead use its enhanced supervisory powers to prevent excessive risk-taking, and focus not only on individual banks but on the risks to the financial system as a whole, he said.
While it is possible that the complexities of the financial system make it difficult to properly oversee, 'I have a more favorable view of the social value of our financial system and the efficacy of supervision and regulation' Evans said, adding that he believes that proper regulation provides the best way to minimize the risks of another financial crisis.
'We can achieve these objectives without having to resort to wholesale changes to the financial system and without degrading our monetary policy goals,' he said.
(Reporting by Ann Saphir; Editing by Chizu Nomiyama) Keywords: USA FED/EVANS STABILITY
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