Essay on Federal Reserve System and Dallas Fed President

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Fed Split Over How Long To Keep Cash Spigot Open

WSJ's Global Economics Editor David Wessel and Chief Economics Correspondent Jon Hilsenrath discuss the Federal Reserve's newest concern: The danger that its easy money policies may fuel another financial crisis.

Federal Reserve officials, uneasy with potential risks springing from the central bank's low-interest-rate policies, are split over an early retreat from the experimental programs created to revive the U.S. economy.

Minutes released Wednesday from the Fed's January policy meeting show officials concerned that the current easy-money policies could lead to excessive risk-taking and instability in financial markets. The Fed is buying $85 billion in mortgage and U.S. Treasury securities a month to drive down long-term rates and has promised to keep short-term rates near zero until unemployment improves.

The program hasn't fueled inflation, as many feared, and many officials are inclined to stay the course. But some said the Fed might have to taper its controversial bond buying before the job market fully recovers, according to the January minutes. The Fed has previously allowed bond buying programs to end in this recovery and then restarted them. It will review the programs at its next meeting, March 19-20, setting the stage for another high-stakes debate.

Behind the Fed's growing unease is a deep change at the central bank since the 2008 financial crisis. Many economists used to regard financial crises as problems of developing economies, and they saw asset bubbles as problems best dealt with after they burst.

Now, Fed Chairman Ben Bernanke said in an appearance at the University of Michigan last month, the Fed "needs to think about financial stability and monetary, economic stability as being in some sense the two key pillars of what the central bank tries to do."

Of late, the view in financial markets has been unsettling: Banks and investors are holding riskier debt. Companies are issuing record amounts of junk bonds. And exotic corners of mortgage securities and corporate loan markets are growing.

Fed officials aren't convinced these recent signs point to any immediate danger to the U.S. financial system. But they are debating whether Fed programs could lead to future financial turbulences and whether the programs will be more difficult to unwind later, as they grow.

The Fed has said that short-term rates would stay low until unemployment falls to 6.5%, from its current level of 7.9%, as long as inflation remains low, and that the bond-buying programs would continue until substantial job market improvements. But officials have always hedged these forecasts, saying they could change with any emerging threats to the financial system.

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The same low interest rates intended to trigger spending, investment, growth and hiring are also spurring a race by investors to find higher returns that, by nature, carry higher risks.

"We have a hyper-robust bond market right now," Dallas Fed President Richard Fisher, a former investment manager, said in an interview. These robust markets are part of the Fed's policy intent, he said, but the credit market jump has put him on guard for a new destabilizing credit boom. "You don't sit on a hot stove twice."

Jeremy Stein, a Federal Reserve governor, likened the Fed's challenge to that of a ship's crew, which must distinguish chunks of ice from dangerous, deep-rooted icebergs. A lot happens in markets beneath the surface, beyond the notice of regulators, he said in a recent speech: "We should be humble about our ability to see the whole picture, and should interpret those clues that we do see accordingly."

Identifying financial threats is harder than spotting such problems as inflation or unemployment, which have uniform measures. Until recently, the long-running complaint among economists critical of the Fed's low-rate policy was the