Fed Likely to 'Sit Back' as Economy Gets Better: Bullard

Unemployment should drop below 8 percent this year as part of an improving economic climate that could take more monetary easing off the table, Fed President James Bullard told CNBC.

James Bullard on Closing Bell
James Bullard on Closing Bell

The head of the Federal Reserve's St. Louis branch said 2011 featured a number of unexpected shocks to the economy — Japan's tsunami and Europe's sovereign debt crisis to name two — that are not as influential in 2012.

As such, he thinks the unemployment rate, currently at 8.3 percent, drops to 7.8 percent by year's end, allowing the central bank to take more of watchful eye and less of an aggressive role in molding economic outcomes.

"With the better data, the super-easy policy already in place — I think we've got a lot on the table here," Bullard said. "So this is a normal situation for the committee to sit back, get more data, try to collect our thoughts about the things that are affecting our economy right now."

The Fed last year implemented what is known as Operation Twist, a $600 bond-buying program that sells shorter-dated notes and buys longer-dated ones in an effort to drive down long-term borrowing rates. The program expires in June.

In addition, the Fed over the past three years has expanded its balance sheet to $2.9 trillion during its two quantitative easingprograms.

Some on Wall Street believe the Fed is gearing up for another round of QE, but Bullard said that is far from a certainty.

"It's a potent weapon that we can use, but we should use it only if the economy deteriorates and especially if the inflation rates come in below our targets," he said. "We're not in that circumstance right now. Headline inflation is above target. Even core (Consumer Price Index) is above target."

Inflation becomes critical for the Fed going forward as its zero-interest-rate policy could trigger higher prices through increasing money supply.

Consumers are burdened with gasoline pricesthat in some areas already have eclipsed $4 a gallon, months before the peak driving season kicks in, and geopolitical tensions surrounding Iran pose threat to additional escalation in prices.

"You have the situation in Iran being a wild card for global oil prices," Bullard said. "So you wouldn't want to feed into that with new policy moves from the Fed."

Bullard joined a handful of Fed officials who said the Fed's easy-money policy is appropriate.

One president, however, criticized central bank policies such as mortgage bond purchases that he said cross the line into fiscal policy.

"Once a central bank ventures into fiscal policy, it is likely to find itself under increasing pressure from the private sector, financial markets, or the government to use its balance sheet to substitute for other fiscal decisions," Plosser told a Chicago conference at which Bullard and several other Fed officials.

John Williams, president of the San Francisco Fed, said the recovery was still sufficiently lackluster to warrant a heavy dose of monetary stimulus.

While he stopped short of calling for additional easing, Williams hinted that he would not be averse to further stimulus from the Fed. Williams was discussing a paper on monetary policy presented at a conference sponsored by the University of Chicago Booth School of Business.

"The paper's executive summary notes that current 'headwinds ... may require a more aggressive monetary response than in normal downturns'. I agree," Williams said.

His counterpart at the New York Fed, William Dudley, said much work remains to achieve maximum U.S. employment and stable prices, and the central bank will do its part.

The pace of the U.S. economic recovery remains "sluggish" and is likely to slow somewhat this year, Dudley added. He said unemployment is likely to remain "unacceptably high" for some time, while inflation is likely to be below the Fed's new 2-percent objective for several years.

Speaking at the same conference as Williams and Bullard, Bank of Canada President Mark Carney praised the Federal Reserve for being "appropriately and effectively radical by implementing a range of powerful unconventional tools."

He said the Fed was able to use the anchor of an explicit inflation target to employ communications as a tool for stimulus.

"We expect that the Fed's elaboration of its longer-term policy goals will enhance the stimulative effect of its announcement that the federal funds rate is likely to remain at exceptionally low levels at least through late 2014," Carney said.