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Fed’s new rate-hike tools passed key test, Fischer says

SAN FRANCISCO (Reuters) – New financial tools meant to help the Federal Reserve pull off its historic interest rate hike last month have worked, easing some internal concerns at the U.S. central bank, the Fed’s vice chairman said on Sunday.

“One possible concern about our unconventional policies has eased recently, as the Fed’s normalization tools proved effective in raising the federal funds rate following our meeting two-and-a-half weeks ago,” Stanley Fischer, the Fed’s second in command, told an American Economic Association conference.

“Of course these are early days yet,” and if issues do arise, the Fed is ready to address them, added Fischer, a close ally of Fed Chair Janet Yellen.

The Fed tightened monetary policy for the first time in nearly a decade last month. To lift rates from near-zero, it relied on a relatively new rate on excess bank reserves and on a lightly tested reverse repurchase (repo) facility to mop up some of the $2.6 trillion in excess reserves in financial markets.

The liftoff, on Dec. 17, boosted the U.S. policy rate into its new target range of 0.25-0.5 percent.

A key topic at the conference was the so-called equilibrium real interest rate: the level of borrowing costs associated with stable inflation and full employment.

The debate over this rate appears set to be a defining focus for the Fed in 2016, as policymakers seek to raise rates quickly enough to head off the threat of inflation but slowly enough to keep the recovery from losing steam.

Fischer said this equilibrium rate, which is key to forecasting by how much the Fed will ultimately tighten policy, is now around zero and is likely to remain low for the “policy-relevant future.”

He added it was difficult to raise this rate, and to mitigate the risks of running monetary policy with near zero rates, as the Fed and other major central banks have done since the 2007-2009 financial crisis.

“Whatever the cause, other things being equal, a lower level of the long-run equilibrium real rate suggests that the frequency and duration of future episodes in which monetary policy is constrained by the (zero lower bound) will be higher than in the past,” Fischer said.

John Williams, the president of the San Francisco Fed, argued earlier in the day that the rate looks likely to stay near zero through at least the end of this year.

Meanwhile, John Taylor, a Stanford University professor who has long advocated for faster rate hikes, argued that the fog of uncertainty around the real level of the rate is too thick to allow good estimates.

As it stands the Fed expects to nudge up rates another four times this year, according to policymakers’ median predictions. They could move faster if asset-price bubbles emerge that are seen as dangerous to overall stability.

Repeating a somewhat controversial view, Fischer said it may be appropriate to lift rates to head off excessively high asset prices across the economy. He did not say that exists now.