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Loose monetary policy needed to counter Washington gridlock: Fed officials

The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst
The sun rises to the east of the U.S. Federal Reserve building in Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Deena Beasley and Karen Jacobs

SAN DIEGO/ATLANTA (Reuters) - U.S. monetary policy is being kept easier to help offset the harm caused by political fighting in Washington, according to two senior Federal Reserve officials who warned on Thursday of damaging consequences if the nation defaults on its debt.

Atlanta Federal Reserve Bank President Dennis Lockhart said the disquiet resulting from the budget battle "vindicated" the Fed's surprise decision not to scale back its asset purchases at its meeting last month.

The Fed's decision to keeping buying bonds at an $85 billion monthly pace startled markets that had expected the U.S. central bank to begin to wind down its ultra-easy monetary policy, sending stocks and gold prices sharply higher.

Critics of the central bank, including some Republicans now confronting President Barack Obama's Democrats over a deal to fund the government and lift the U.S. debt ceiling, have complained the Fed's loose policy risks future inflation and financial instability.

The Fed indicated last month that part of the reason it delayed action was the economic headwinds caused by the fiscal fights in Washington.

"I think we avoided a potentially very awkward situation of reducing stimulus just on the eve of what now has developed," Lockhart told reporters in Atlanta.

Gridlock between Democrats and Republican Tea Party conservatives in the U.S. House of Representatives has triggered a government shutdown this week and it could lead to default if lawmakers fail to raise the nation's borrowing limit.

The Obama administration warned earlier on Thursday that a default could have catastrophic consequences, potentially tipping the economy back into a recession as severe as the 2007-2009 downturn and rivaling the Great Depression.

Dallas Federal Reserve President Richard Fisher warned separately that a default would profoundly unsettle financial markets.

"The unthinkable will have become real, and the 'full faith and credit' of the United States will be a mirage rather than an accepted fact," he said in Dallas.

LOWER FOR LONGER

The Fed has held interest rates near zero since late 2008 to hasten the economic recovery while more than tripling the size of its balance sheet to $3.7 trillion through three rounds of massive bond purchases aimed at holding down borrowing costs.

John Williams, head of the San Francisco Fed, said the economic constraints caused by decisions in Washington, which have already choked growth this year after lawmakers raised taxes and cut government spending, were forcing the Fed's hand.

"Every time there is another factor holding us back, whether it is tax policy, whether it is spending ... it just means we have to keep interest rates lower for longer. We have to do more active purchases," he told an audience in San Diego.

Policymakers have repeatedly said they cannot fully compensate for the impact of tighter fiscal policy or the uncertainty caused by Washington gridlock, but they have a duty to try their best.

"We just have to do more of what we can do ... to, as best we can, offset the influences on the economy from what is happening in Washington," Williams said.

The Fed has already committed to holding rates near zero until unemployment hits 6.5 percent, provided the outlook for inflation does not rise above 2.5 percent. Williams, stressing that this threshold was not a trigger for rate action, said he did not expect the first hike until the second half of 2015.

(Additional reporting by Ann Saphir in Dallas, Writing by Alister Bull; Editing by Ken Wills)

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