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Fed should beef up low-rate vows, two officials say

A view shows the Federal Reserve building on the day it is scheduled to release minutes of the Federal Open Market Committee from August 1,
A view shows the Federal Reserve building on the day it is scheduled to release minutes of the Federal Open Market Committee from August 1,

By Alicia Underlee Nelson and Richard Valdmanis

FARGO, North Dakota/BANGOR, Maine (Reuters) - The U.S. Federal Reserve ought not to raise interest rates until the economy is much closer to full strength, two of the Fed's most dovish policymakers said on Tuesday.

"If you commit to keeping rates low even as the recovery is proceeding, even as we continue to recover, I think people have a sense, the Fed has the recovery's back," Minneapolis Federal Reserve Bank President Narayana Kocherlakota said at North Dakota State University. "And that's the message that I think we need to do a better job of promoting."

If households and businesses believe the Fed is close to raising rates, they may decide to save rather than to spend, inhibiting recovery, Kocherlakota said.

But because inflation is so low, he said, the Fed can afford to remain accommodative even while the recovery strengthens, and it will likely need to raise rates only gradually when the time comes.

Inflation firmed a bit last month but remains well below the Fed's 2 percent target.

Meanwhile unemployment, at 6.7 percent, remains well above the 5 percent to 6 percent level that most economists consider normal.

Separately, in Bangor, Maine, Boston Fed President Eric Rosengren floated the idea of promising to keep interest rates near zero until the U.S. economy is within one year of reaching the central bank's employment and inflation goals.

"Ideally, forward guidance should, for the time being, remain qualitative but increasingly be linked to progress in achieving our dual mandate based on incoming economic data," Rosengren said at Husson University. "Forward guidance should be consistent with keeping interest rates at their very low level until we are within one year of reaching full employment and our 2 percent inflation target - and the guidance could explicitly state that intention."

Rosengren and Kocherlakota have both supported more aggressive monetary easing than many of their fellow policymakers.

In December, Rosengren dissented from the majority's decision to begin to pare back the Fed's massive bond-buying stimulus.

Last month Kocherlakota cast the lone dissent on the Fed's decision to stop promising low rates as long as unemployment remains above a set level.

Both policymakers have argued that the Fed should only cautiously remove accommodation and be patient in raising rates from near zero, where they have been since late 2008.

Since then, the Fed has tried an array of strategies to telegraph just how long it will wait to tighten monetary policy, including tying the ultra-low rates to time periods, and later, to specific unemployment and inflation thresholds.

Many investors have grown confused and impatient with the Fed's varied communications efforts. Last year, for example, talk by Ben Bernanke, when he was the Fed chairman, of eventually trimming bond purchases led to a sharp rise in market-wide borrowing costs that alarmed policymakers.

Last month, Janet Yellen, who took over as Fed chair at the start of February, rolled out the central bank's latest version of forward guidance, effectively promising not to raise rates for a "considerable time" after the Fed halts its bond-buying program; the Fed has begun to trim its bond purchases and they should end by December at the latest.

But Yellen sowed more confusion when she then told a press conference that a "considerable time" means about "six months" or so.

Kocherlakota suggested on Tuesday that rates should stay lower for much longer than that, based on the low rate of inflation.

"I can say that I am fully committed to doing whatever it takes to keep inflation close to 2 percent," Kocherlakota said. "And if we start to see inflation pressures so that inflation starts to go above its current 1 percent level and up to closer to 2 (percent) or rising above 2 (percent), then that's when rates will rise."

But, he also said, inflation looks likely to stay well below 2 percent for several years.

Separately on Tuesday, Yellen said the Fed is considering further steps to force big banks to hold more capital, and sees a case for other stability-enhancing measures for more shadowy areas of Wall Street as well.

She did not address monetary policy in her remarks to a Fed conference in Atlanta, but is expected to do so when she addresses the New York Economic Club on Wednesday.

(Writing by Jonathan Spicer and Ann Saphir; Editing by Ken Wills)

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