While assessing the outlook for growth and unemployment, policy makers are debating the risk unconventional easing may speed up medium-term inflation or create price bubbles for some types of assets. At the current rate of bond purchases, the central bank’s record $3.08 trillion balance sheet will grow this year by $1.02 trillion.
Fed Governor Jeremy Stein said this month some credit markets, including leveraged loans and junk bonds, show signs of potentially excessive risk-taking.
“We are seeing a fairly significant pattern of reaching-for-yield behavior emerging in corporate credit,” Stein said in a Feb. 7 speech in St. Louis. He said the central bank may have to consider higher interest rates and changes to its balance sheet policies to respond to imbalances in credit markets.
“I can imagine situations where it might make sense to enlist monetary policy tools in the pursuit of financial stability,” he said.
The asset purchases could also complicate the central bank’s strategy to return its balance sheet to more normal levels. The Fed in 2007 held less than $900 billion in assets.
Kansas City Fed President Esther George said last week the central bank may trigger instability in financial markets when it starts selling bonds.
The Fed’s plan for selling securities “could be potentially disruptive to markets and market functioning,” George said in a speech at the University of Nebraska-Omaha. “These actions are untested by the Federal Reserve and could cause an unwelcome rise in mortgage interest rates.”