HONG KONG: Federal Reserve Bank of San Francisco President Janet Yellen said it's "far from clear" whether the Fed should use interest rates to stem a surge in financial leverage, and urged further research into the issue.

"Higher rates than called for based on purely macroeconomic conditions may help forestall a potentially damaging buildup of leverage and an asset-price boom," Yellen said in the text of a speech yesterday in Hong Kong.

At the same time, "use of monetary policy for these ends necessarily compromises the attainment of other macroeconomic goals," she said.

Yellen's remarks come just as debate arises over whether the Fed's current commitment to keep rates low for an "extended" period may be fueling rising asset prices in Asia. While officials from the Chinese mainland, Hong Kong and Japan said in the past week that the stance is spurring speculative capital, Fed Chairman Ben S. Bernanke said on Monday it's "not obvious" there's a bubble in the US.

"Further research into the connections among monetary policy, the banking and financial sectors, and systemic risk is needed to help answer this question," Yellen, a voting member of the rate-setting Federal Open Market Committee this year, said in her remarks, referring to whether to use rates to influence asset prices.

The San Francisco Fed chief also endorsed the idea of making banks hold more capital than otherwise during economic expansions, for use when recessions hit. She said that "one promising strategy is to implement a system that would require banking organizations to build capital buffers in good times that could be run down under stressful conditions."

Bernanke said yesterday that reduced bank lending and "high" unemployment are likely to restrain the recovery, warranting continued low borrowing costs.

The FOMC pledged after a November 3-4 meeting to keep the benchmark interest rate near zero for an "extended period".

The central bank's injection of more than $1 trillion in liquidity has helped end the US economy's contraction, pushing up stock prices. The effort has narrowed the Libor-OIS spread, which measures banks' reluctance to lend, to levels not seen since 2007. The Standard & Poor's 500 Index is up 64 percent from its low for the year on March 9.

Donald Tsang, the chief executive of Hong Kong, said last Friday in Singapore, "I'm scared and leaders should look out."

Emerging economies "might overheat and experience financial turmoil", Bank of Japan Governor Masaaki Shirakawa said in Tokyo yesterday.

Bernanke, by contrast, said in response to audience questions after a speech in New York that "it's not obvious to me in any case that there are any large misalignments currently in the US financial system."

Fed Vice Chairman Donald Kohn, speaking on Monday, also said low rates don't appear to be fueling another bubble in US financial markets.

Yellen, 63, previously served as a Fed governor, was White House Council of Economic Advisers chief in the Clinton administration and has led the San Francisco Fed since 2004.

Bloomberg News

(HK Edition 11/18/2009 page4)