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Fed officials say rates should not be used to fight bubbles

By Ann Saphir

PALO ALTO Calif. (Reuters) - A trio of Federal Reserve officials who disagree deeply with one another over the appropriate stance of monetary policy on Friday expressed a shared distrust for using interest rates to head off asset bubbles and other forms of financial instability.

Both Richmond Fed President Jeffrey Lacker, a policy hawk, and San Francisco Fed President John Williams, a centrist, told reporters after a policy conference here that they would not want to risk unmooring the public's expectation that inflation will rise back to the Fed's 2 percent goal in the next few years.

That, Williams said, is what appears to have happened in Sweden and Norway after those countries raised rates to address financial stability risks. Fed economist Andrew Levin had shown a slide making that point earlier at a presentation that both policymakers attended.

Chicago Fed President Charles Evans, one of the Fed's most ardent doves, echoed those sentiments.

"Degrading monetary policy tools to mitigate financial instability risks would lead to inflation below target and additional resource slack," Evans said in slides released Friday for a talk he is set to give in Istanbul on Monday.

The role financial instability concerns should play in Fed policymaking has long been a subject of debate at the U.S. central bank. Over the past year, Fed Governor Jeremy Stein has argued strongly that there may be times when the Fed should raise rates to stamp out potential bubbles.

Stein left the Fed earlier this week to return to his post at Harvard University, leaving the Fed without a forceful public advocate of that idea.

Philadelphia Fed's Charles Plosser told reporters on Friday he was "kind of on the same page" as Williams and Lacker, in terms of rejecting a financial stability mandate for the Fed.

But he added that he is worried about the risk that the Fed's extraordinarily easy policies over the past five years themselves could stoke financial instability.

Williams, Lacker and Plosser were in Palo Alto attending a central banking conference put on by Stanford University's Hoover Institution that also featured Kansas City Fed President Esther George.

On Friday, Williams reiterated his view that rates, near zero since December 2008, should not rise until next year and should do so only slowly. That's the view also of Fed Chair Janet Yellen, who has said rates will stay low for a "considerable time" after the Fed winds down its bond-buying program this coming fall.

Lacker said he would support an immediate tightening of monetary policy by selling the Fed's holdings of mortgage-backed securities, but added that the size of the Fed's balance sheet will not prevent it from carrying out proper monetary policy.

Plosser said he would be open to varying approaches toward trimming the Fed's massive balance sheet, which now tops $4 trillion after years of stimulative bond-buying, but said his preference is for an eventual return to a smaller balance sheet.

(Reporting by Ann Saphir)

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