04/28/2011 04:29 pm ET Updated Jun 28, 2011

Federal Reserve's Actions May Increase Unemployment, Fed Economist Says

The Federal Reserve's purchases of more than $2 trillion in mortgage and U.S. government debt may cause an upswing in unemployment, a top regional Fed official argued Thursday in a new paper that counters the central bank's position.

The forecast by Yi Wen, an assistant vice president and economist at the Federal Reserve Bank of St. Louis, challenges a chorus of pro-purchase research published by the Fed's Board of Governors in Washington and its regional banks in San Francisco and Boston.

The Fed's $2.3 trillion asset-purchase programs could lead to a 2.2 percent rise in the unemployment rate in the long term, Wen wrote. The economist argued that the increase in bank reserves -- a result of the Fed's buying programs -- could lead to an increase in the amount of money flowing through the economy, which in turn would lead to inflation. Over time, that would lead to an increase in joblessness, he reckoned.

Some within the Fed -- as well as members of Congress, and foreign central bankers and political leaders -- have publicly criticized the central bank's recent initiatives. Detractors say the Fed lacks the tools to withdraw the record stimulus before it causes runaway inflation. Once money is in the system, they argue, it will inevitably lead to rising prices.

Fed Chairman Ben Bernanke has countered that the poor state of the economy and near-record unemployment compels the central bank to be aggressive. The Fed has tripled the size of its balance sheet to further bring down interest rates in an effort to spur borrowing and spending.

The San Francisco Fed argued in January that those efforts, known as quantitative easing, will create 3 million jobs by 2012. The most recent round of purchasing, known as QE2 and scheduled to run through June, will lead to 700,000 new jobs, the researchers, who include San Francisco Fed President John C. Williams, forecast in their paper.

Fed Vice Chairman Janet Yellen endorsed that research in a January speech to economists in Denver. Bernanke said at his Wednesday press conference that the purchasing programs have been successful and that the number of jobs created as a result have been "significant." The Boston Fed predicted in November that the Fed's asset purchases would lead to 700,000 new jobs through 2012.

By purchasing U.S. Treasury obligations and mortgage securities from Wall Street firms, the Fed increases the amount of cash at those banks. Banks are parking $1.47 trillionat the Fed beyond what is required by regulators, Fed data from last week showed. Unused, that stashed cash simply collects interest at a rate of 0.25 percent from the Fed.

Fed officials, including Yellen, Bernanke and New York Fed President William Dudley, have said the central bank will be able to drain the excess bank reserves before they lead to significant inflation.

But if the Fed cannot successfully manage the exit from their record stimulus program, Wen's forecast could become a reality.

An annual increase of 1 percent in the amount of money in the economy would have "almost no impact on unemployment" during the first five years, Wen wrote. But, later, a growing money supply could lead to a rise in the unemployment rate of 1-2.2 percent, Wen argued. A surge of money in the system would lead to higher prices because the value of money would decline. That would in turn lower growth and increase joblessness, he wrote.

The unemployment rate stood at 8.8 percent as of last month, according to the Labor Department. It's decreased by a full percentage point since November.

On Wednesday, the Fed forecast unemployment to average 8.4 to 8.7 percent during the last three months of this year, then falling to 7.6 to 7.9 percent during the fourth quarter of 2012.