–Adds detail on monetary policy, crisis measures

FRANKFURT (MNI) – Federal Reserve Bank Vice Chairman Donald Kohn
said Friday that central banks need to show the will and the means to
exit non-standard measures.

Changing a central bank’s inflation target is risky, Kohn told an
audience at an event honoring outgoing ECB Vice President Lucas
Papademos.

He said that the anchoring of inflation expectations is even more
important as banks approach the zero bound of interest rates.

Exit tools are “very important” for central banks, Kohn argued.
“You need to know how are you going to raise rates [and] need to show
people that you not only have the will but also the means to do it.”

The Fed is “also developing tools to absorb reserves to back up”
any potential increase in interest rates to “make sure that it is
effective,” he explained.

“It is critical that central banks have the exit strategies in
place and are able to explain to the public that they are in place.”

The extra tools that a central bank employs must be dependent on
the inflation outlook, Kohn noted.

“I also agree as many have said that central banks need to pay much
more attention to indicators of financial imbalances and financial
stability,” he said.

With respect to liquidity facilities, it is important to ensure
that central banks not take on too much tail risk and that more of the
risk be taken on by private institutions, he said.

“One lessons is that once the policy rate is at or close to zero,
expectations about future policy is even more important than it is when
rates have a place to move,” he said.

“Central bank purchases of assets are particularly helpful when
markets are illiquid,” he explained. “When normal arbitrage is
disrupted, we saw that in US, and we are seeing it in Europe today.”

As stated in their minutes, the FOMC’s “intent is to get back to a
portfolio that is basically treasuries only,” Kohn said.

In answering audience questions, he admitted that the Fed “did a
lot of uncomfortable things in the crisis, but I think they were
absolutely necessary to fulfill our legislative mandate.”

“I think over time people are [starting] to recognize that.”

Still, “central banks should not be involved in credit allocation
on a regular basis,” he argued. “But in an emergency it may be the only
way of pursuing the higher objective of stabilizing the economy.”

–Frankfurt bureau; +49-69-720142, frankfurt@marketnews.com

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