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Fed officials offer divergent views on inflation risks

Published: October 16, 2012 | 8:11 am
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Federal Reserve officials offered divergent opinions on Monday about the correct stance for monetary policy, differing most sharply on the inflation risk posed by the central bank’s massive efforts to buoy U.S. growth.

The Fed, which meets to review policy next week, in September announced a third round of quantitative easing and pledged to keep interest rates near zero until mid-2015 in an effort to underwrite a durable economic upswing.

Anti-inflation hawks were outnumbered by the doves on the Fed’s policy-setting committee, who view inflation as a distant threat in the face of tepid U.S. growth and high levels of joblessness, plus other gauges of economic slack.

“If we were to see some good news on growth I would not expect us to respond in a hasty manner,” said William Dudley, president of the New York Federal Reserve and a close ally of Fed Chairman Ben Bernanke.

U.S. retail sales notched a brisk 1.1 percent gain last month, data released earlier on Monday showed, as Americans bought more goods in an upbeat sign of economic activity.

That news, which promised faster economic growth ahead, followed a sharp drop in unemployment last month to 7.8 percent, which brought the rate below 8 percent for the first time in 3-1/2 years, although it remains high by historic standards.

Dudley, a voting member of the Fed’s policy setting committee, also told the National Association for Business Economics at an event in New York on Monday that fears the Fed’s extraordinary stimulus steps will cause financial asset bubbles or inflation were misplaced.

He said the Fed’s ability to adjust the interest it pays banks to park funds there – called interest on excess reserves, or IOER – “means we can keep inflation in check regardless of the size of our balance sheet.”

The Fed last month announced a new open-ended bond buying plan of $40 billion in mortgage debt purchases per month until it sees a significant improvement in labor market conditions.

This follows purchases of $2.3 trillion since interest rates were lowered to near-zero in late 2008, which has ballooned the size of the Fed’s balance sheet to $2.81 trillion.

San Francisco Fed President John Williams, who like Dudley voted for the latest round of stimulus, said he expects the Fed’s asset purchases will put slight upward pressure on inflation – and that’s a good thing.

Inflation has averaged 1.3 percent over the past four years, close to the lowest rate recorded over any four-year period since the mid-1960s, “which seems to be at odds with a lot of commentary that the Fed is creating inflation,” Williams told the Financial Women’s Association of San Francisco. “In no way has our commitment to price stability wavered.”


That sanguine view of the inflation risk posed by the Fed’s actions was disputed by Richmond Federal Reserve President Jeffrey Lacker, who dissented against the policy easing last month and voiced concern about the impact on price stability.

“The behavior of inflation is fundamentally attributable to the actions of the central bank, while growth and labor market conditions are affected by a wide variety of factors,” he told a business conference in Roanoke, Virginia.

Lacker said that while the Fed had the tools – in theory – that would allow it to shrink the balance sheet and lean against inflation, the exercise had never been conducted in real-life, sounding a note of scepticism over how confident policymakers should be that they can do so when the time comes.

He also voiced doubt that the U.S. economy was really running so far beneath its so-called trend growth rate, and that there is not much more monetary policy can do at the moment to spur the economy.

“Simply observing a high unemployment rate does not imply that the Fed’s monetary policy is failing to comply with its congressional mandate, nor does it necessarily mean that monetary policy needs to do more to achieve its goals,” he said.

Congress has given the Fed a dual mandate to seek maximum employment and stable prices.

Some economists argue that U.S. growth will remain very subdued for several more years in the aftermath of the housing collapse that caused the recession and say the Fed has limited ability to alter this outlook.

Lacker said the recent pattern of employment growth, with 146,000 jobs per month added in the third quarter, suggested a slowdown earlier in the year had been transitory.

Lacker said the Fed’s guidance that it will keep rates low until at least mid-2015 could send the wrong message.

“It could be misinterpreted as meaning that the Committee believes the economy will be weaker than people had thought. By itself, that could have a dampening effect on current activity, which is not what was intended,” he said.

U.S. growth cooled in the second quarter to 1.3 percent, and forecasters do not think the economy will manage a pace any faster than 2 percent for the rest of the year, although most see it picking up somewhat in 2013.

St. Louis Fed chief James Bullard raised his next year growth estimate to 3.5 percent, from a previous call of a pace above 3 percent. He told the Missouri Council on Economic Education that he saw unemployment dropping toward 7 percent over the course of the year, the St. Louis Fed said.

But U.S. growth has repeatedly undershot forecasts as it has gradually recovered from a severe recession in 2007-2009, and Dudley cited this experience for a reason why policy “needed to be still more aggressive,” as well as to guard against shocks.


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