–Updating 20:50 ET Story, Additional Detail

By Steven K. Beckner

SAN FRANCISCO {MNI) – San Francisco Federal Reserve Bank President
John Williams said Wednesday that, although the economy is showing signs
of improvement, it still faces “serious menaces” and therefore the Fed
will likely have to continue its so-called quantitative easing “well
into the second half of next year.”

Williams, a voting member of the Fed’s policymaking Federal Open
Market Committee, also reaffirmed that the FOMC will keep the federal
funds rate near zero well after the economy improves.

The FOMC is obligated to take these steps because it is “falling
short” on both its maximum employment and price stability mandates, he
said in remarks prepared for the University of San Francisco.

Williams insisted the Fed is “not wavering” in its commitment
to low inflation as it at pursues faster economic growth. He said
inflation fears are unwarranted, and indeed he projected that
inflation will stay below the Fed’s 2% target even as GDP growth
picks up from 2% this year to 2.5% in 2013 and 3.5% in 2014.

“As it stands then, unemployment is well above our mandate,
inflation is below our target, and the recovery faces serious menaces,”
he said after citing risks from Europe, from the U.S. “fiscal cliff” and
from general business uncertainty.

“In this situation, the Fed must take action to keep our economy on
track towards maximum employment and price stability.”

On Sept. 13, the FOMC, with Williams support, authorized the New
York Fed to buy $40 billion per month of mortgage backed securities
until the labor market shows “substantial” improvement.

But Williams, who projected that the unemployment rate to stay
above 7% at least through the end of 2014, said he expects “it will be
some time until the job market makes substantial progress towards our
congressionally mandated maximum employment goal.”

“Therefore, I anticipate that we will need to continue our
purchases of mortgage-backed securities and longer-term Treasury
securities past the end of this year and likely well into the second
half of next year in order to best achieve our mandated goals,” he
continued. “The ending date for these programs will hinge on the
performance of the economy.”

Beyond asset purchases, the FOMC said it would hold the federal
funds rate near zero “at least through mid-2015″ and added it expected
to keep rates exceptionally low “for a considerable time after the
economic recovery strengthens.”

Interpreting that statement, Williams said, “In other words, we
intend to keep short-term rates low even as the economy improves to make
sure this recovery takes hold.”

Williams did not touch on what the FOMC ought to do when the $45
billion per month purchases of Treasury securities under “Operation
Twist” expire at the end of December in his text.

But, as he has before, he left the door open for replacing those
Twist purchases, at least in part, with enlarged QE3 purchases.

“Unlike our past asset purchase programs, this one doesn’t have a
preset expiration date,” he noted. “Instead, its duration and the total
amount that we purchase will depend on what happens with the economy.”

“Specifically, we said we’ll continue buying mortgage-backed
securities until the job market shows substantial improvement,” he went
on. “But, if we find that our policies aren’t doing what they’re
supposed to do or are causing significant economic problems, we’ll
adjust or end them.”

Although some of his colleagues have expressed skepticism about the
efficacy of the Fed’s third round of large-scale asset purchases,
Williams said QE3 and the FOMC’s extended forward guidance on the
federal funds rate are “having the desired effects.”

“Take mortgage interest rates,” he said. “Our purchases of
mortgage-backed and Treasury securities have helped push conventional
30-year mortgage rates to historically low levels under 3 1/2%. And low
mortgage rates are a great way to pep up the economy.”

Williams said low mortgage rates “make owning a home more
affordable, which increases demand for housing. Higher demand puts
upward pressure on house prices, making it easier for existing
homeowners to refinance or sell their homes. The happy result is a
virtuous circle of growing confidence and improving fundamentals in the
housing market.”

“And, over the next few years, a homebuilding rebound should be a
key driver of economic growth, creating more jobs for construction
workers, furniture salespeople, real estate agents, and the like,” he
said.

Already, he noted, there are improved home prices, home sales and
housing starts.

Another area of encouragement is auto sales, he said.

But Williams said the Fed can’t relax because the economy faces
“serious menaces.” Even if a deal is reached to avoid the “fiscal
cliff,” he predicted fiscal restraint will exercise a “drag” on growth.

Meanwhile, inflation is not a threat, he said, pointing to 1.7%
average inflation over the past year.

“The concern I hear most often is that our securities purchases
might ignite a bout of inflation,” he said, but “in my view, that worry
isn’t warranted.”

“The fact is, the economy isn’t operating at full speed,” he
explained. “We have lots of spare economic capacity and an abnormally
high number of workers who can’t find jobs. That keeps inflation in
check by making it hard for businesses to raise prices or for workers to
press for higher pay.”

** MNI **

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