Federal Reserve chairman Ben Bernanke signalled he would keep the Fed's target interest rate low to support the economy, even as some colleagues warned the policy risks triggering financial market instability.
"Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading - ironically enough - to an even longer period of low long-term rates," Bernanke (pictured) said on Friday in a speech in San Francisco. "Only a strong economy can deliver persistently high real returns to savers and investors."
Bernanke in congressional testimony last week defended the Fed's US$85 billion in monthly bond purchases, saying the benefits of reducing borrowing costs and fuelling growth outweighed any potential costs.
The Federal Open Market Committee is debating when to curtail the bond-buying amid concern the stimulus may encourage asset-price bubbles and complicate the Fed's eventual reduction of its US$3.09 trillion balance sheet.
The Fed chairman said in response to audience questions that "monetary policy can be a relatively blunt tool for addressing problems in a given market". He cited the Fed's attempt in the 1920s to raise rates to blunt a stock market boom, and the subsequent Great Depression, to warn of the risks from using interest rates to restrain financial markets.
Bernanke said the central bank seeks to avoid causing disruptions by holding at 0.25 per cent the interest rate it pays on reserves that banks keep at the Fed. He said he had "concerns on the effects of functioning of markets" if the Fed cut the rate to zero.
In his remarks, Bernanke expanded on his argument that the Fed's accommodation remains warranted. By allowing the economy to regain its footing, long-term rates will gradually rise, providing a better return to savers than if the central bank raised rates now, Bernanke said.
"If, as the FOMC anticipates, the economic recovery continues at a moderate pace, with unemployment slowly declining and inflation expectations remaining near 2 per cent, then long-term interest rates would be expected to rise gradually toward more normal levels over the next several years," he said at a San Francisco Fed conference on monetary policy.
Bernanke devoted the bulk of his speech to an analysis of why longer-term interest rates in much of the world have fallen to near record lows. The yield on the 10-year Treasury note hit a record 1.379 per cent on July 25 and has since risen to 1.84 per cent.
Bernanke's remarks were also a response to an FOMC debate that has emerged publicly over how to confront financial instability that could be provoked by an extended period of very low rates.