A Fed Insider Warns of the Risk of Low Rates

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The Federal Reserve official who sent the market into its most volatile week of the summer over fears of more aggressive interest-rate increases couldn’t have been a more unlikely candidate for that distinction.

Boston Fed President Eric Rosengren has a well-established reputation as one of the Fed’s leading doves—advocates of easy-money policies aimed at spurring faster economic growth. But more recently he has developed strong concerns that easy money could be letting markets get out of hand the way they did before the financial crisis. And he’s publicly urging his colleagues to act before it gets too late.

“It’s not costless to get the unemployment rate very low,“ Mr. Rosengren said in an interview Sept. 9. “The tools we have are quite blunt,” so it’s better to get ahead of potential problems, he said.

Mr. Rosengren wasn’t explicitly calling for the Fed to raise short-term interest rates at its meeting this Tuesday and Wednesday. Officials are divided over when to move, making it likely they’ll wait until later this year. Futures markets put low odds on a rate increase this month.

But he warns that the Fed needs to consider the effects of very low rates in fueling bubbly asset prices. His main source of concern is commercial real estate—the soaring market for office buildings, warehouses and apartment buildings.

According to the Boston Fed, lending to the sector totaled $3.6 trillion as of March, with just over half of that provided by banks and the rest from financial firms such as pension funds and life insurers.

Prices have been rising steadily across the country since the end of 2009, the Boston Fed said. Mr. Rosengren worries the gains are being driven in part by the scramble for returns in the low-yield world brought about by the Fed and its overseas counterparts, rather than by the fundamentals of supply and demand.

“Should prevailing economic conditions change in response to a large negative economic shock, commercial real-estate prices could decline relatively quickly, leading to large losses at leveraged firms,” he said in an Aug. 31 speech in Beijing. That, in turn, could trigger a broader economic downturn, he said.

The comments that sent markets tumbling came Sept. 9 in Quincy, Mass, when Mr. Rosengren said “a reasonable case can be made” for raising rates to avoid overheating the economy.

Most notably, he made the case for raising rates to head off financial instability despite the fact that this would slow the Fed’s progress toward its goals of fostering job growth and 2% inflation—an unusual statement of the cost-benefit trade-offs.

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