Fed's Kohn-weak economy likely to persist

WASHINGTON (Reuters) - U.S. Federal Reserve Vice Chairman Donald Kohn said on Wednesday shakiness in the economy and the financial system are likely to continue for an extended period and that regulation, not rate rises, were the most effective prevention against future asset bubbles.

"Although the outlook remains extremely uncertain, both the fragility of the financial system and the weakness in real activity seem likely to persist for a while," Kohn said in remarks prepared for delivery to a conference at the Cato Institute.

Kohn said the economic mess that began with risky lending and questionable financial market practices in the United States would take longer to clear up than past shocks because of the size of the problem, the key role housing plays, and the extent to which banks have been exposed to losses.

"The economic disruption here and abroad is likely to be considerably more severe than in past episodes," he said.

In spite of the serious damage done by the bursting of the housing bubble and its aftermath, Kohn said he remains skeptical that central banks can anticipate and prevent asset price bubbles by raising interest rates.

"I am not convinced that the events of the past few years and the current crisis demonstrate that central banks should switch to trying to check speculative activity through tighter monetary policy whenever they perceive a bubble forming," Kohn said.

Rather than using the blunt tool of adjusting interest rates, policy-makers should examine more careful use of regulation and supervision to address concerns about potentially dangerous behavior, he said.

Kohn said a good part of the appreciation in house prices was probably fueled by the expansion of subprime lending and the wider use of securitization markets, which boosted demand for mortgages from investors.