New Fed governor backs bond buys while warning of diminishing returns

One of the Federal Reserve's newest officials threw his support behind the central bank's latest round of stimulus, even as he suggested further rounds in the future could show diminishing returns.

Fed Reserve Governor Jeremy Stein hit a similar tone as Fed Chairman Ben Bernanke in defending the recent move to embark on a third round of "quantitative easing." The Fed decided in September that it would buy $40 billion of mortgage bonds a month until the labor market improved, in a bid to lower borrowing costs and spur economic activity.

Stein contended that the move, fiercely criticized by Republicans, made sense because the economy was growing so slowly it appeared the job market would remain laggard. At the same time, inflation appears to be under control, making it easier to take the plunge on more easing, he contended.

"It appears that the economy is growing at a pace such that, absent policy action, progress on reducing unemployment will likely be slow for some time," he said in remarks at the Brookings Institution. "Meanwhile, inflation is subdued, running at or below our long-run objective of two percent, while inflation expectations remain well anchored."

If the Fed had not already lowered interest rates effectively to zero, current conditions would make for an "open-and-shut case" for reducing them, Stein said. But because the Fed lowered rates as far as it could years ago following the financial meltdown, the Fed is now left to look for less traditional policy tools, such as quantitative easing.

At the same time, Stein hit a note of caution on easing, warning that future rounds of easing could show diminished returns in the economy.

"We could in principle push this tool to the point that the hurdle for additional usage would become very high," he said.

Skeptics of "QE3," including many GOP lawmakers, contend that the massive expansion of the Fed's balance sheet that comes with these purchases encourages inflation down the line, when it comes time for the Fed to sell those assets back into the marketplace.

Stein sought to assuage those concerns, contending that the Fed is well aware of the risks and is confident in its ability to keep prices under control.

"If the [Fed] needs to act in the face of an emerging threat to price stability, there is little doubt in my mind that we can," he said. "As to whether we will, the Federal Reserve has repeatedly made clear its commitment to both sides of its mandate — to price stability as well as to maximum employment."

The remarks mark Stein's first public speech since he joined the Fed. The Harvard economics professor was confirmed by the Senate in May by a vote of 70-24, alongside Jerome Powell, a Treasury under secretary under President George W. Bush. He was confirmed by a vote of 74-21.

President Obama nominated the pair in December.

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