Dennis Lockhart

The hedge funds' share of this market increased from 3 percent to 28 percent between 2000 and 2006.  If credit experience gets rocky, will these participants stay in the market? And could they affect liquidity if they leave?

As reported by Bloomberg News

In the diverse Southeast economy—with the pressure of globalization and technological change—the required skill set will change constantly. We hear often that a person who will spend 40 years in the labor force may have not only multiple jobs but also three or four distinct careers. For many, personal retooling is not just a choice—it's a matter of survival. Fortunately, state leaders are well positioned to ease this sometimes painful process by investing in programs to foster worker retooling.

So far, I have not seen hard or soft data that provide conclusive signs that housing problems are spilling over into the broad economy.

Second, in my view, we're witnessing more than just a repricing of risk. The credit markets of recent years feasted on a low cost of capital through leveraged investing and aggressive financing structures at both the retail and wholesale levels. I believe we're also seeing a broad retreat from higher-risk practices, such as

• no document/no equity mortgages,
• covenant-light leveraged buyouts, and
• the carry trade—in other words, borrowing in one currency to invest unhedged in debt instruments in another.

I believe we've been experiencing the unpleasant process of the financial world changing its ways after a prolonged period of relatively cheap credit, and in consequence, high leverage. What we've been going through is an intense adjustment in both price and practice, and this process may be continuing. 

The linkages are complex, but here is my synopsis of recent market turmoil. Since mid-2006, home price appreciation slowed, and recently prices have fallen in some markets. Earlier in 2007, markets perceived that subprime mortgage credit quality was deteriorating markedly. Delinquencies among subprime borrowers have been rising and are expected to continue to rise as many borrowers have difficulty refinancing. The initial low rates on their adjustable-rate mortgages are resetting to higher rates that imply much higher monthly payments. At the same time, stagnant housing prices have eliminated their option of refinancing at lower rates or selling their house at a profit.

The spike in delinquencies has affected not only the mortgage holders but also other segments of financial markets, including the market for asset-backed commercial paper. As background, the commercial paper market links investors directly with corporate borrowers without intermediation by banks. About half the current commercial paper market is so-called SIVs that invest in financial assets. Holders of the asset-backed commercial paper obligations of SIVs came to recognize the increased risk and, in many cases, refused to roll over or refinance the short-term debt of these borrowers.

In turn, the securities that included significant amounts of the subprime mortgages became hard to value. The secondary market for these securities shrank dramatically. I would describe this development as a closed loop. Valuation uncertainty reduced secondary market trading. Little or no trading made it even more difficult or impossible to value the securities by market price.

Faced with these valuation difficulties, broader market participants have become wary of classes of structured debt securities beyond subprime. For instance, markets for jumbo prime mortgages also experienced liquidity problems.

Investment funds believed to be heavily exposed to subprime mortgage—backed securities and other structured debt securities have faced some redemptions and cancellation of borrowing facilities used to acquire the securities in the first place. This development forced sales of other classes of securities in their portfolios, and institutional sponsors of these investment funds have been called upon to support their distressed funds.

Many investment funds bought these securities "on margin" (using debt), and this fact is important. By employing leverage, many funds pursued enhanced returns. Efforts by investment funds to improve their liquidity and reduce exposure to risky assets involved reducing the amount of outstanding debt. This process—called deleveraging—appears to be widespread across the financial system.

The recoiling from risk in general is affecting an unrelated market—the leveraged loan market used by private equity deal sponsors. This market has backed up markedly—loan commitments intended to be syndicated have not been able to close because of weak distribution prospects. By some estimates, more than $400 billion of such financings are in backlog.

As you know, I'm a new central banker and policymaker. But I bring to this new role experience in the financial sector touching on a wide range of business lines, asset classes, and types of institutions. I know during a feast there is a strong incentive for market participants to meet the competition and seek competitive advantage by pushing the risk-reward envelope.

Some of this pushing of limits amounts to sustainable innovation. Many of these innovations served desirable ends and allocated greater risk to those investors who had an appetite for it. The subprime mortgage market has brought the American dream of home ownership to many people who previously could not qualify for mortgage loans. These developments, on balance, have been a good thing. But some pushing of limits, in my view, will prove to have been imprudent excess.

My first principle is let markets work.  The second principle is the central bank has a responsibility to promote orderly conditions in financial markets, stepping in as necessary to avoid severe system disruption.  The third principle is to make sure the second principle doesn't undermine our long-term mission.

There are certainly tensions to be resolved in applying these principles, and formulating measured responses to circumstances requires good judgment, particularly in transitional periods.  I believe we are in such a period now.

"Last Thursday, I said in a speech that I have not seen conclusive signs of weakness in the broader economy,'' Lockhart, 60, said at an event sponsored by the Atlanta Business Chronicle. ``Friday's data, however, shows employment was beginning to soften back in June. This news should be evaluated with recently positive reports in retail sales.''    

As reported by Bloomberg News

While inflation is currently at the upper bounds of my comfort zone, the Fed has made progress against it. That's why I believe the recent moderation of inflation readings allowed a tactical move to reduce risks to the general economy with a fed funds rate cut.

I take the TIPS spread or the steepening of the yield curve as an indicator of market sentiment, market belief.  But I don't think any single indicator is definitive.

From the Q&A session, as reported by Bloomberg News

``My intention was very much to signal neutrality on that decision. Where I come out on that question will depend on the spectrum of indicators and inputs we get, some of which are not necessarily data but anecdotal.''    

"I am neither signaling further cuts, or my recommendation of such, nor am I signaling I think we are finished.''

From the Q&A, as reported by Bloomberg News

First, let me comment on moral hazard...  I did not see the logic of subordinating the general welfare of our nation's economy to the possibility that some participants in financial markets might draw tainted conclusions about the future landscape of risk. My view is that fulfilling the Fed's institutional purposes takes precedence.

Business investment is another area I'm monitoring. At present, however, troubles in credit markets do not appear to have restricted nonfinancial businesses' access to credit. But I'm listening to business contacts for indications they are getting more cautious with spending and hiring plans.

Another director said, of the current financial turmoil, "When you swim in the ocean, you don't know who's naked 'til the tide goes out."

My responsibility at the FOMC is to contribute to national policy formulation. I am not there to represent the interests of the Southeast—rather to extrapolate from the situation in this part of the country to the national picture.

Toward the end of our lunch I asked, "What's it like to formulate monetary policy?"  [Bill Ford] thought for a moment and gave me a playful response. He said formulating monetary policy is like flying an airplane in low visibility conditions and choppy air. As the pilot, many times you see clouds and not much else. So you rely on your instruments, which are like economic data. The difficulty is half of the readings may be off, and you don't know which half at any given time.

...

Twenty-five years ago Bill Ford equipped me with a useful metaphor of flying an airplane in low visibility as a way to think about my current responsibilities. Will the aircraft glide in for a soft landing? In my opinion, the answer is yes. I believe the current Fed policy abets a flight path of lower but still positive growth with moderate inflation. More turbulence may be ahead. So keep your seatbelts fastened.

Currently, I believe long-term inflation expectations remain anchored, and measures of current inflation have decelerated during the year from elevated levels in 2006. ...  Going into the Sept. 18 FOMC meeting, my opinion was that the balance of risks to the economy had shifted from higher inflation toward slower real growth. I believed, and still do, that the factor weighing most heavily on this change in the outlook has been the potential negative ramifications of the financial turmoil.  

Despite the positive readings on recent economic performance outside the housing sector, my forecast calls for below trend, slower GDP growth in the fourth quarter of 2007 and first half of next year. This forecast anticipates further weakness in housing in the near term and the likelihood that declines in housing wealth will contribute to a weakening of the pace of consumer spending.  

In addition to growth, I'm keeping a close watch on prices. Readings on inflation have improved this year, and I believe that inflation will most likely continue to moderate as measured by so-called core inflation indices. But there are some inflationary risks. In particular, recent increases in energy and commodity prices, among other factors, could put renewed upward pressure on headline inflationthe inflation you and I encounter in the marketplace.

The FOMC noted on October 31 that "economic growth was solid in the third quarter, and strains in financial markets have eased somewhat." However, the committee added "the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction." The committee believed its October 31 policy action, combined with its action taken in September, "should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time."

As discussed a moment ago, my view of the economy is consistent with the FOMC statement, and I supported last week's policy action. In part, my position was based on the notion of insurance against downside risks to the general economy given the unusually high level of uncertainty.

If I were to use one word to characterize our current economic circumstances, that word would be "uncertain." Much of this uncertainty relates to the potential depth, length, and impact of the housing downturn and potential flow-back to Main Street from the turbulence we have seen on Wall Street.

In my view, the most likely story line is one involving a moderate slowdown in economic activity over the coming quarters, with a return to growth near trend by late 2008 as the housing sector begins to recover. Underpinning this story is the view that our modern market economy has a keen ability to self-correct as opportunistic capital moves into depressed markets. Markets correct. And market solutions are preferable. This transition already is happening in the market for subprime mortgages. In this story, financial markets may endure some more weeks or months of volatility, but I believe they will find a restructured state of "normality," involving improved risk management practices, reduced leverage, and greater transparency.

An appropriate public policy posture is to be supportive of market solutions in the financial markets.

Over the last several decades we've seen an evolution from a bank-centered financial intermediation system to a market-centered system. As a result, lenders have become investors, loan spreads have become investment yields, and individual loans have become the feedstock of pools of like assets brought together through a process known as securitization. These changes have had significant implications both for loan underwriting and where in the system loans are ultimately held. In terms of underwriting, the old "banker-looking-borrower-in-the-eye" business model has been largely replaced by an "originate and distribute" business model.

We're going to look at data as it comes in, and in these times we take very seriously anecdotal information that we get from various contacts across the country.

From Q&A session, as reported by Bloomberg News

At this juncture, the times present even greater uncertainty than usual. The negatives in our economy may be gaining momentum. I think these circumstances call for policymakers to be prepared to respond pragmatically to whatever developments arise. 

The Term Auction Facility seems to address a liquidity need, and we're continuing it because that liquidity need is still there. ...  
My sense is there's a preference for using the Term Auction Facility as a mechanism, and also because it doesn't carry the same stigma content. ... The communication has been quite adequate. I would defend the communication practices and policies that we've carried out in the last few weeks. From press Q&A session, as reported by Market News International

Recently, negative information has been exceeding expectations. I think these circumstances call for policymakers to be prepared to respond pragmatically. In my view, pragmatism in the face of growing weakness in the general economy may very well require additional moves to lower the federal funds rate.

As a policymaker, I feel acutely the tension between the need to promote growth and guard against the specter of higher prices. Implicit in my view is the forecast that inflation will moderate, allowing policy to focus on the very apparent near-term risks to the broad domestic economy.

For 2007, the consumer price index increased 4.1 percent—the largest calendar-year increase since 1990. The core CPI (excluding food and energy costs) increased 2.4 percent, which is above my comfort zone.

As I prepare for each FOMC meeting, I gather real-time anecdotal economic intelligence from a variety of sources. I talk to, among others, bankers, hedge fund managers, and other financial market players. In my most recent conversations in December, they voiced serious concern about further—and spreading—market deterioration and potential spillover into the broad economy. From my contacts in the nonfinancial world, I generally get less strident impressions of current economic circumstances. Not long ago, I heard qualitatively different perceptions from Main Street versus Wall Street. But in recent weeks almost all were quite worried about the economic outlook.

Recent employment data affected many observers' assessments of the risks to the economic outlook. Moreover, analysis by my staff suggests that the employment picture for 2007 was weaker than recent statistics indicate.

Lockhart said fiscal policy and discussing possible stimulus is the purview of the Treasury Department, but noted $75 billion to $100 billion is a "sensible" figure.

From audience Q&A as reported by Market News International

I think the recent turmoil has shown that, in fact, banks retained a central role in the originate-to-distribute credit intermediation model. ... While banks have taken hits in the recent turmoil, their central role has been reconfirmed and their inherent strengths accentuated. The scale and scope of our larger banks and their broad earnings power have cushioned the losses. And their franchise strength has aided recapitalization.

While I see banks recovering, I see little chance that we will revert to the old approach of originate-to-hold-in-portfolio model. Market-based credit intermediation provides substantial gains from diversification and transparency that are not available in the old model. And I see little chance banks in their various forms won't remain the cornerstone institutions of our financial system.

I believe recent actions helped address the risks to the economic forecast I just referenced—that is, weakness in the first half of 2008 followed by improvement in the second half, with inflation moderating from recent levels. The liquidity injections and easing of monetary policy should help housing and financial markets stabilize and avoid an "adverse feedback loop" in which a continuing decline in housing prices fuels financial market volatility with spillover to the broader economy.

In response to recent economic circumstances, the Federal Open Market Committee (FOMC) acted decisively. Over a period of nine days, from January 22 to January 30, the FOMC lowered the fed funds rate 125 basis points, from 4.25 to 3 percent. Since last August, the committee has dropped the fed funds rate 225 basis points.

These actions were taken to avert a deep and protracted economic downturn. In the face of economic weakening, the FOMC acted to avoid a restrictive posture and get rates to a level I believe will support movement toward trend growth by the second half of 2008.

Rating agencies are already undertaking their own reforms, but ratings are unlikely to be as singularly dominant as they have been in some markets in recent years. Moreover, investors and rating agencies will not soon forget the lessons of recent months in evaluating pool probabilities. Tail events can materialize and, given recent experience, seem to do so with higher frequency than was contemplated by the models employed—models that were built for other purposes and products.

So, as we move out of the current turmoil, I see the U.S. markets headed toward a "new normal," not a return to normal. The recent turmoil has discredited the more dubious innovations of the past few years. But the foundation of earlier innovations over the past three decades delivered too much value for us to return to the "old-old" ways of finance.

I believe the contours of the new normal will be:

• a reformed, market-based system with a strong role for banks;
• the continuation of securitization more narrowly applied and with strengthened origination, structuring, and risk evaluation practices;
• better investor practices with more self-reliance, along with a substantially reformed rating agency industry;
• simplified and standardized instruments; and
• much refined risk management practices on the part of all market participants.

As I hope you detect, I am optimistic that the trauma of recent months will pass and our credit capital markets will be better for the lessons learned.

My baseline forecast envisions weakness in the first half of 2008 followed by improvement in the second half, with inflation moderating from recent levels. The liquidity injections and easing of monetary policy should help housing and financial markets stabilize and avoid an "adverse feedback loop" in which a decline in housing prices fuels financial market volatility with spillover to the broader economy.    

I think concerns about sovereign wealth funds can be overwrought. To the extent that trade and capital-account imbalances are the source of potential instability, the answer is to address the fundamental causes.

At this point conclusions about cause and effect are more speculation than science. But I am persuaded that the liquidity conditions created by foreign-owned dollar surpluses trying to find an investment home in this country contributed to markets' recent unstable conditions.

I am also persuaded these financial imbalances are not likely to disappear in the foreseeable future. We must live with them, and policymakers must be mindful of them.

In my view, we should not—in pursuit of market order—impose excessive regulatory constraints that undermine the innovation and competitiveness that are, in the long run, the foundation of thriving financial markets and institutions.

Finally, in my view, we should not become identified with "investment protectionism." Trade protectionism is widely understood and debated. Investment protectionism refers to differentiated treatment of capital providers based on national identity and citizenship as well as denial of certain investment opportunities to nonresidents or noncitizens. There are some legitimate national security concerns in certain industries, such as defense, but such concerns can be easily exaggerated.

[G]enerally favorable economic conditions should help improve financial market stability. In recent quarters, economic growth has slowed considerably. The Federal Open Market Committee (FOMC) lowered the federal funds rate from 5.25 percent last September to the current level of 3 percent. This reduction should encourage stronger economic growth in the second half of 2008.

I would characterize the current state of affected financial markets (those most affected by the subprime problem) as evolving positively but still fragile—in other words, unusually vulnerable to shocks. Affected markets are working through problems of counterparty mistrust, lower or no trading volume, reduced new origination, and plummeting market prices that may be well below eventual economic value. For instance, investors have been reluctant to roll over asset-backed commercial paper because of the linkages to subprime mortgage–backed securities purchased by structured investment vehicles, or SIVs. The asset-backed commercial paper (ABCP) market has shrunk over $400 billion since August of last year, and major investors have exited, possibly permanently.

I would argue that root causes of problems in the subprime market brought into question some fundamental practices, incentives, and even institutions of other markets. By fundamentals, I mean the integrity of origination (that is, the quality of assets that went into securitization pools), the structure of the securities into which loans and individual securities were packaged, and the value of these securities as collateral for margin financing.

Also, rating agencies had greatly underestimated the risk of many mortgage-backed securities. This led to a loss in confidence in the ratings assigned to other complex financing structures with further reductions in liquidity and increases in the volatility of prices across a variety of debt markets.

Through this spread of suspicion, subprime losses exposed related problems elsewhere, such as the syndication market for leveraged loans. Some leveraged lending underwriting was in its own way very aggressive in the period before the markets turned rocky starting last summer.

Finally, the subprime crisis generated a thicket of doubts concerning counterparties. Uncertainty about valuations of securitized debt fed uncertainty regarding the exposure of large banks and other market participants, which led to concerns about executing trades with these counterparties.

Looking ahead, I believe resolution of the current financial market problems requires some stabilization of U.S. housing markets. At this time, it's difficult to determine when that stability will materialize.

There is concern that there are in fact structural limitations on the ability of consumers to finance consumption.

From audience Q&A as reported by Market News International

Earlier in the week I had a briefing on the pandemic flu risk. And this morning I was at the Carter Center hearing about the eradication of the guinea worm, and here we are at lunch talking about subprime lending. All relate to contagion... I guess it's the theme of the week.

From audience Q&A, as reported by Market News International

[It is a] very difficult policy to intervene in the workings of markets at a particular chosen time.

It's difficult to identify, it's difficult to choose timing, difficult to be sure that market forces themselves will not have what
turns out at the end to be a positive effect.

From audience Q&A, as reported by Market News International, saying he's not "comfortable" with the Fed pre-emptively targeting asset bubbles.

[T]he ability of reductions in the federal funds rate to address liquidity strains in credit markets has proven to be limited.

A continuation of these liquidity strains presents a serious potential risk to the financial system. As a result, the Fed in recent months has undertaken additional steps to directly improve liquidity conditions in key credit markets.

A week ago Sunday, the acquisition of Bear Stearns by JPMorgan Chase was announced. Earlier this week, the deal was changed from the original $2 per share to $10 per share, and certain specifics were adjusted. To facilitate this transaction, the New York Fed—through a limited liability company formed for this purpose—will take control of a portfolio of assets valued at $30 billion as of March 14. JPMorgan Chase will bear the first $1 billion of any realized losses in this portfolio, and any gains will accrue to the New York Fed. The arrangement was undertaken with the support of the U.S. Treasury.

This action was taken to bolster market liquidity and promote orderly functioning of short-term funding and credit risk markets.

Looking ahead, my forecast has been affected both by an economic slowdown that has been sharper than I had expected and the recurring spells of financial market turmoil. A few months ago our forecast at the Atlanta Fed saw growth slow in the first half of 2008, then pick up in the second half of the year. But it now appears to me that the contraction in housing and the dampening effects of financial turmoil on household and business spending could persist through the remainder of this year. The recovery in growth I had expected in the second half of this year may be delayed.

The tax rebates should provide some stimulus in the second and early third quarters of this year. But given the uncertain atmosphere I expect will continue to prevail in May and June, I do not expect full flow through of the rebates into personal consumption expenditures.

I expect it will take much of the rest of the year for house prices to bottom out and financial markets to restore the necessary preconditions of stability—that is, confidence in asset values and confidence in transaction counterparties.

Looking ahead further to 2009, my outlook becomes more optimistic. It will take longer than I earlier expected to return to solid growth, but by the fourth quarter of 2008 the conditions should be in place to support a return to healthy growth next year.

The line that separates restoring market function from merely redistributing losses and gains is not a bright one. This is the reason that policymakers only rarely and reluctantly intervene in markets.

Also, the distinction between liquidity problems and insolvency is not a trivial one when monetary authorities respond to troubles of market players. The critical evaluation is the systemic risk posed by the failure of an institution.

Some believe the Fed has overreacted. Others have said the central bank has been slow to respond to building problems. And still others have warned that the Fed has crossed lines that define appropriate function.

But from where I stand, Fed actions were taken with a prudent acknowledgement of the unintended consequences that may accompany almost all policy interventions.

With regard to financial conditions more broadly, markets have not yet stabilized. Although financial instability originated in the residential mortgage-backed securities market, it has spread to affect a variety of credit markets via market linkages or institutional interdependencies. The experience has been traumatic, at times generating primal emotions. Market volatility has been driven by fear, distrust, and flight to safety. I emphasize this point because financial system stability is a central focus of Fed policy at the moment.

At the same time, inflation has become a more prominent concern.

It's possible—given certain strengths such as strong business balance sheets and export growth—that the economy will not pass the threshold into a technical recession. In considering the current economic situation, I believe that an important policy objective at this juncture is to ensure that this slowdown is short and shallow.

A critical factor—possibly the critical factor—in the determination of the length and depth of the current slowdown is the performance of the housing sector.

[I]t's clear the economy is in a slowdown that resembles past periods that were the leading edge of a recession. Economic growth has been slowing since the third quarter of last year coming off solid growth rates in the second and third quarters of 2007. Following a sluggish fourth quarter, I expect that GDP for the first quarter of this year will show little, if any, growth.    

As we begin this year's conference, the still unsteady condition of credit markets is no doubt at the top of the mind for most.

Recent events will very likely initiate a new round of financial reforms.

No doubt some of these efforts have been appropriate. In other cases, there may have been some regulatory overshoot -- new rules doing as much or more harm than good.

The U.S. economy is in the midst of a pronounced slowdown, with very little growth recorded for two consecutive quarters. The weakness was initially centered in the housing sector but has become more widespread.

It used to be said that when the United States sneezes, the world catches pneumonia. A better metaphor for today would be that when the United States gets a cold, the world gets a cough and the sniffles.

My view is the following: Global economic integration has progressed in recent years to the point that a slowdown in the United States will unquestionably be felt, but not as severely as imagined by some. Domestic growth momentum in many emerging economies will attenuate the influence of U.S. weakness. And the accumulation of foreign currency reserves by these countries—the result of trade surpluses—provides an accessible resource to stimulate their own domestic growth to offset weaker exports, should that weakness materialize.

We expect inflation to abate somewhat in the second half and going into 2009 based upon our forecast of weak economic growth. ... There is some early indication that the strength of inflation has softened.

From Q&A as reported by Bloomberg News.

There has been a fair amount of handwringing recently about sovereign wealth funds accumulating U.S. assets. I believe our posture has to be realistic—one country's trade deficit (ours, in this case) is another country's investment surplus.

I'm hoping breathing will come more easily as the year plays out, as we enter 2009 and as immediate challenges subside. But recent experience tells me we won't be fully at ease until a sustainable trade, energy, and fiscal balance has been achieved.  

   ``The relatively modest changes, reforms, related to the Libor panel were anticipated so I was not at all surprised on
where they came out.
     ``As I step back from this I think the mechanism of setting the Libor rate is an enormously important part of our financial system. Even if it says `London' at the beginning of the phrase, it has an enormous effect on U.S. interest rates, including mortgage resets and corporate borrowing.
     ``It has had over the years a record of serving well and with some tweaks and reforms I think it can continue to serve. It would be extremely difficult to move wholesale to a different index.''

From Q&A session with the press, as reported by Bloomberg News

"The U.S. economy is in the midst of a pronounced slowdown, with very little growth recorded for two consecutive quarters. The weakness was initially centered in the housing sector but has become more widespread." 

I do not expect this country to experience the same protracted economic weakness as Japan, in part because we can learn from Japan's experience in order to avoid something similar.    

My base case forecast for the economy involves a stronger-than-expected first half of 2008 with growth of 1 to 2 percent but not much pickup in the second half. The drag of high energy costs, continuing financial market stress, and a still-declining housing sector may continue for a while with gradual improvement of growth in 2009.

There is much uncertainty surrounding this outlook. More adverse alternative scenarios are entirely possible. Self-reinforcing progressive deterioration could continue in the housing market, in turn affecting the financial markets. And neither the financial markets nor the overall domestic economy is protected from surprise events around the world.

Let me emphasize that I'm taking the recent inflationary pressures very seriously. A path to recovery involving stronger growth but with higher and persistent inflation would fit the old adage about winning the battle but losing the war.

For that reason, in my view, the current set of circumstances calls for being especially vigilant and attentive to public and business psychology as regards costs and prices. Policy needs to react decisively against signs of the onset of formal compensating practices, including contracts, that treat inflation as a persistent reality—in other words, something that must be lived with. Such signs are not apparent, and I don't expect them to materialize.

From my perspective, I like policy where it is.  I view the current situation as reasonably balanced, with a great deal of uncertainty around both the downsides to growth and the upsides to inflation….If the inflation numbers remain high -- which is another way of saying if I'm wrong -- then I may support action earlier.  The outlook for the second half of the year and going into 2009 is we'll see some alleviation of inflation pressures. Having oil and other commodities come down so strongly helps.

…

I would characterize today's markets as still showing some stress. Credit spreads have been somewhat rising.  The healing process of the financial sector is going to take some time.  I think it is reasonable to assume there will be some more pain before we really completely see a turn.

I would not rule out any action {on interest rates}.  I think we have to react to circumstances.

The housing market still has some way to go.  We see relatively few signs that house prices have bottomed out.

Some fear inflation expectations are on the move in reaction to recent experience. As suggested a moment ago, I don't hold that view. But I feel that it's important to acknowledge that not enough is known about transitional periods from one state of expectations to another. Even though we're measuring expectations, there's an element of looking back to gauge their essence. I do not dismiss the view that we run the risk that by the time change in expectations is clear, it's too late. In my view, we need to know more about how and why inflation expectations shift.

That said, years of hard work by economists have gone into developing the measures of inflation expectations we currently track. And I have challenged our Atlanta Fed research staff to build on this progress.

My belief is that the Fed has undertaken tactically prudent actions to help move the economy through a difficult transition in line with the larger strategic goals of sustainable growth, low and stable inflation over the long term, and financial stability. Also, let me emphasize that I am mindful of today's elevated risks and am prepared at any point to change tactics to ensure inflation expectations do not become unanchored.

The 12-month inflation rate through July was measured at 5.6 percent, the highest since 1991. This is a high and worrisome number...No matter how you measure it, the aggregate inflation we are experiencing in the United States at the moment is uncomfortably high.

...
I expect the recent decline in oil prices will begin to reverse some of the pressures we have seen on overall inflation in the first half of the year. But the underlying global supply pressures remain tight, and demand pressures remain relatively high. As such, any relief will likely be only partial.

Furthermore, some government estimates suggest little respite from food price hikes in the near term. At this point, it seems quite probable that PCE index inflation this calendar year will clock in at more than 3.5 percent and the CPI somewhere north of 4 percent—an improvement over the first half of the year, and trending in the right direction, but not numbers I would be comfortable with over the longer term.

Although recent measures of inflation are higher than I would like to see, I would say that recent price increases are more likely to be transitory than persistent. I expect that CPI inflation will peak near the July level of 5.6 percent. By comparison, in March 1980 the CPI peaked at 14.8 percent.
...
I concur with that view and believe current Fed policy is consistent with an easing in overall inflation given the dynamics of the economy. With weak growth and financial market strains, I believe the most likely outcome is that both headline and core inflation will diminish over the rest of 2008 and into next year as the temporary effects of energy and food price increases abate. Note that my outlook does not require that food and energy prices fall, but simply that their rates of increase moderate.

In my view, the compositional differences {between the CPI and PCE price index} don't clearly favor one index versus the other. While the level of the inflation rate measured by the two indices differs at any point in time, over the short term both generally give the same signal about the pattern of inflation.

Taken together, measures of both CPI and PCE inflation are important tools to help get a fix on the overall inflation picture, giving us a sense of whether the inflation is persistent or transitory along with other information needed to make informed policy decisions.
...
I agree with those who say core inflation measures in isolation are an inadequate approach to determining the direction of overall price changes. Like you, I ultimately care about the trend rate of overall inflation, which I believe is ultimately the appropriate object of monetary policy.

Early in the last century, the economist Irving Fisher offered a vivid metaphor for the movement of individual costs relative to the aggregate level of inflation. The general inflation, he said, can be thought of as the movement of the swarm of bees. He likened the relative movement of individual prices (both up and down) to the movement of individual bees within the swarm.

A working financial sector matters to us all. Credit is the lifeblood of a modern economy. Illiquid credit markets mean illiquid banks and ultimately illiquid businesses. I don't need to explain to a room full of businesspeople what happens when credit dries up and a business becomes illiquid. Cash becomes king, efforts are made to accelerate inflows, and cash outlays are reduced. Managers focus on discretionary expenses, and then the biggest categories of cash outflows—salaries and investments. Jobs, and livelihoods, are at stake.

"I'm working under the assumption that it is most realistic at this stage that there will be no comprehensive program as was envisioned in the Treasury {TARP} proposal," Lockhart told a local group in New Orleans. "The most realist approach is to assume we are moving forward dealing with whatever developments come up on a one-by-one basis," he said.

From the Q&A session, as reported by Dow Jones

By any measure, September was historic. The events of September contributed substantially to a fundamental restructuring of this country's financial system. It also brought a transition from an incremental approach, including the Federal Reserve's various measures to provide much-needed liquidity to markets, to a comprehensive attack on the diverse elements of the crisis.

...

Looking ahead at the U.S. economy, this is a period of vexing uncertainty...With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures. Nevertheless, given high inflation readings during the summer and into the fall, I'll continue to watch developments closely.

We at the Atlanta Fed expect weakness to persist for some time into 2009 as credit markets gradually improve. The thawing of credit markets is a necessary condition for a recovery back to levels of growth consistent with the economy's underlying potential.

The near-term economic outlook is not encouraging. The incoming data in September and October have been worse than expected, and these results pushed my staff and me to revise downward the Atlanta Fed's outlook for the economy.

I foresee substantial weakness at least through the first half of 2009. This weakness will exacerbate the employment picture. In my outlook, unemployment will rise some more.

If there is anything positive in this near-term outlook, it is the trajectory of prices. I expect headline inflation to decline over the coming months and fall into an acceptable range below 2 percent by 2010. Over the longer term, inflation experience is influenced by inflation expectations. Encouragingly, the University of Michigan consumer survey's reading for October shows a moderation in inflation expectations both for the year ahead and for the longer term.

Recent data indicate that the national economy is in recession. Economic activity as measured by real gross domestic product (GDP) declined an estimated 0.3 percent at an annualized rate in the third quarter, according to the advance estimate. Data for October suggest an even steeper decline in GDP for the fourth quarter.

It's impossible to measure what economists call a counterfactual—what might otherwise have happened. But without a willingness to use all available tools and to adapt policy tools as conditions required, I'm convinced the economy's performance and current outlook would have been considerably worse.

Looking ahead, the overall economy is very weak, and I expect it will remain weak at least through the first half of 2009. The incoming data suggest fourth quarter GDP contracted somewhere between 4 and 6 percent (annualized). And this quarter's performance could be similar. At some point—perhaps later this year—I believe financial markets will have stabilized sufficiently to support a recovery. So I am looking for an improving economy in the second half. To temper that a bit, there is always the risk of a shock or reversal in the financial sector or elsewhere that could again alter the outlook to the downside.

...

To buttress confidence, I want to assure you the Federal Reserve still has considerable ammunition in reserve to be used as needed.

(T)here are two aspects of this (asset-focused) policy approach—growth of the Fed's balance sheet in absolute terms and change of the composition of assets. Even with the federal funds rate effectively at zero, there is ample scope to do more of both if conditions require.

In terms economists use, the policy rate has reached its zero lower bound. This situation has raised concerns that the Fed can't do any more to combat recession and that monetary policy—broadly defined—has lost relevance at a crucial point in time. I would argue that a federal funds rate this low will have considerable macroeconomic effect especially if accompanied by policies to improve the functioning of credit markets.

Among the programs in force is the direct purchase of agency (Fannie Mae, Freddie Mac, etc.) notes and mortgage-backed securities. These securities are directly linked to mortgage rates. Purchases began just a few days ago. The goal of such a program is not, in my view, to engineer a particular interest rate level, that is, to hit a particular rate target. But direct purchases can promote directionally lower rates, help restore normal market functioning, and thereby achieve a return to reliance on private sector market-based credit allocation.

The introduction of targeted asset-side measures has been aimed squarely at the breakdown of credit markets, the circulatory system of our modern economy. In my view, a precondition of economic recovery is the return of the normal functioning of credit markets.

Let me emphasize that this asset-focused approach is a departure from what the textbooks describe as conventional monetary policy and is not without controversy. Some have called it credit policy to distinguish it from the conventional approach where the central bank achieves its objectives through its influence on bank reserves on the liability side of the balance sheet.

As I look ahead, signposts on the road to recovery include sustained normalization in credit markets and stabilization of house prices. Also, I'm watching for an uptick in business spending to give a sign of a return of opportunity seeking and private sector risk taking needed to sustain growth.

Economic forecasts—particularly when looked at collectively—provide valuable information for risk managers in their underlying assumptions and their information about the degree of uncertainty in the economic environment. I would argue they are less useful as point predictions of data elements or timing of turning points.

Forces that produce the beginnings and ends of recessions are particularly difficult to predict. Turning points are anomalous events and by their very nature are more difficult to see than variations around a more or less linear scenario, by which I mean continuity from past to present.

As a consequence, economic forecasts will tend to be overly optimistic as the economy goes into a recession but overly pessimistic as the economy comes out of recession and begins its expansion. Perhaps we should take some comfort in that observation today.

I think there are some other lessons to take away from the experience of the last two years. Tail risks—low probability but extremely consequential events—do sometimes materialize. Ignoring tail risks—"black swans," in the words of author Nassim Taleb—may be irresponsible. Because forecasting is an inexact exercise, because shocks by nature aren't anticipated, and because both theoretical models and econometric models cannot incorporate actual complexity, policy must sometimes take what we call a "risk management" approach. Policymakers occasionally need to take out insurance against economic tail risks, and this approach is especially relevant when traditional relationships have broken down. Case in point: Our models are based on a history where financial markets are working.

I have been predicting an upturn in the overall economy beginning in the second half of 2009, with a slow and gradual return to our full economic potential. To temper that outlook a bit, uncertainty remains unusually high, and one has to be mindful of very real downside risks, including a further deterioration in real estate.

"I am apprehensive" about what the February nonfarm payrolls report will show, the official said. "I am preparing myself for a bad report," Lockhart said.

The official was responding to reporters' questions following a speech before the Greater Miami Chamber of Commerce.  As reported by Dow Jones News

Economists expect trade to decline during an economic slowdown. But the recent sharp contraction of trade appears to be far more severe than would be expected given the decline in global economic activity.

I believe some of the fall in international trade can be attributed to the disruption of the interbank credit system. The marked reduction of interbank lending appetite has been associated more with the market for short-term liquidity, but it also has affected trade credit. With the interbank liquidity crisis, banks have moved to reduce overall counterparty exposure including trade credit

I expect securitization to continue because this form of financial intermediation developed in response to needs and realities that have not disappeared. I was a commercial banker in the 1980s and I remember well the onset of the practice of balance sheet allocation according to return on assets and ultimately return on equity. Commercial banks were, and remain, caught in a dilemma of wanting to serve their clients by providing loans, but not always being able to justify booking very competitively priced loans on their balance sheets.

My outlook calls for the beginning of a recovery in the second half of 2009. I do not expect a strong recovery, but I do expect the economic contraction we're now experiencing to give way to slow and tentative growth as early as the third quarter.

I trust this topic {Meeting the Challenges of the Financial Crisis} is appropriate for a conference in honor of Hyman Minsky. As you know, he devoted much of his academic life to the forces that give rise to financial instability and the important role that institutional arrangements play in both the promotion of, and the remedy to, financial instability.

I expect the financial system to continue to involve a mix of capital markets and institutions, but with a wider array of institutions falling under regulatory supervision. Furthermore, I take it as given that there will continue to be large international institutions with operations in many countries, that is to say, regulatory jurisdictions around the globe.

Looking ahead, I see an ongoing role for securitization and the originate-to-distribute model. Securitization markets have shrunk dramatically over the last year and a half and in some cases have shut down altogether. I expect these markets to return, perhaps in simpler form and with more accountability.

In my view, the postcrisis environment will require agile oversight. This regulatory approach should stress actively managing risk as it evolves with the associated potential for an institution failing versus an approach that focuses on avoiding failure.

I’m sympathetic to the view that policy has to be anticipatory.  If you wait too long you may not be able to address what could at that time be increased inflation expectations and inflation impulses in the economy.

As reported by Market News International.

Higher nominal rates in the term Treasuries market can be seen as an expression of creeping doubt that the American polity, and more specifically the policy community, is up to the sacrifices, tradeoff decisions, and the courage of convictions the situation requires.

The concerns about our economic path are crystallized in doubts expressed in some quarters about the Federal Reserve's ability to fulfill its obligation to deliver low and stable inflation in the face of very large current and prospective federal deficits. In a word, the concerns are about monetization of the resulting federal debt.

I do not dismiss these concerns out of hand. I also recognize that the task of pursuing the Fed's dual mandate of price stability and sustainable growth will be greatly complicated should deliberate and timely action to address our fiscal imbalances fail to materialize. But I have full confidence in the Federal Reserve's ability and resolve to meet its inflation objectives in whatever environment presents itself.

The rise of Treasury rates, or yields, has been characterized as both good and bad omens. Various interpretations have been put forward. To wit:

• The rise of term Treasury rates reflects the improved outlook for real growth.
• The rise of term Treasury rates signals declining risk aversion and the unwinding of the safe haven inflows that occurred last fall.
• The rate rise demonstrates increased inflation expectations related to concerns of monetization of the burgeoning federal debt.
• The rise is evidence of decreased demand on the part of foreign investors.

These and possibly other explanations may all be factors in the market. I'm sympathetic to the good omen explanations—that the rise is connected to the improved outlook—but I don't rule out that there is something here to monitor very carefully. The steepening of the yield curve may reflect growing concern over the nation's ability to correct profound structural imbalances; that is, to combine recovery with transition.

In the normal course of our work, the Atlanta Fed produces a forecast of economic growth, unemployment, and inflation. Like most forecasters, we see the economy beginning to recover in the second half of this year.

For the medium and longer term, however, I expect growth will be relatively subdued for some time after it turns positive. My thinking is the economy has to go through structural adjustments that could lower the trend rate of growth for the recovery's first couple of years at least.

Moreover, I believe there are ongoing threats that pose downside risks to sustained recovery.

Current economic conditions are mixed at best, but the economy appears to be in stabilization mode. Stabilization necessarily precedes recovery. A recovery has not yet taken hold but should begin before too long.
…
Data on the overall economy suggest the same trend of slowing decline. I, along with my team in Atlanta, believe real gross domestic product (GDP) fell slightly in the second quarter. This performance represents substantial progress coming off a contraction of 5.5 percent (annualized) in the first quarter.

The most recent monthly labor market report was disappointing, but employment tends to lag improvements in economic performance. Nothing in the incoming data has altered our view that the economy is nearing a bottom and will soon begin a very slow recovery.
...
Often a deep recession is followed by a sharp rebound in business and overall economic activity. Unfortunately, as I look ahead, I do not foresee this trajectory. I expect real growth to resume in the second half and progress at a modest pace. I do not see a strong recovery in the medium term.

Many observers see substantial slack in the economy that could persist for some years. Economists' more formal term for slack is “output gap.” We at the Atlanta Fed see a meaningful output gap developing, but in our view it is smaller than would normally be associated with the weak pace of growth we expect over the next couple of years because all the obstacles to the natural pace of growth already mentioned have brought down the economy's potential for the medium term.

At this juncture, my assessment is that inflationary and deflationary risks are roughly balanced.

[E]vidence is mounting that the worst of the economic downturn is behind us...Overall, the U.S. economy is improving but still fragile. Stabilization has taken hold, and the beginning stages of recovery are under way.

Fortunately, most who are directly affected by job loss are eligible for the short-term income support of unemployment insurance. Benefits through that program have been extended three times since July 2008 and may be extended again.

[I]t's too early to be contemplating a rise in the fed funds rate target.

As reported by Dow Jones Newswires.

I am sympathetic to the view that policy-makers should consider intervention in certain circumstances. That may simply be by speaking against the practices ... as opposed to taking action with interest rates.

As reported by Reuters.

At this time I'm not overly worried about inflation prospects...Neither expectations nor the key indices tell me at this time that I need to be overly concerned about inflation.

[T]he U.S. economy is improving but still fragile. Stabilization is proceeding, and the first stages of recovery are under way.
...
Often a deep recession is followed by a sharp rebound in business and overall economic activity. As I look ahead, at least beyond the third quarter, I do not foresee this trajectory. Over the medium term, I see a slow recovery with ongoing repair of the financial sector and structural adjustments in the broad economy.

[T]he Federal Reserve System has a characteristic that is somewhat unique among central banks of the world. The system has a decentralized structure whereby regional, independent Reserve Banks, under the broad supervision of politically appointed governors in Washington, D.C., jointly set policy.

This decentralized structure, in my view, greatly enhances both the independence of the system and its transparency.

The concern expressed in some quarters over the growth last year of base elements of the money supply—namely, excess bank reserves and the Fed's balance sheet—strikes me as exaggerated. When the time comes, I am confident the Fed has the tools to reverse the assumed monetary stimulus and exit the policies put in place in reaction to the financial crisis and the recession.

I agree with all who are declaring that a technical recovery is underway. We are technically in recovery when a contracting economy gives way to growth. But even vigorous growth off a low bottom does not necessarily bring back prior activity levels for some time. By most estimates, it will be the second half of 2010 before the 2007 levels of national output are reached.

To repeat my current assessment, while the CRE problem is very worrisome for parts of the banking industry, I don't see it posing a broad risk to the financial system. Nonetheless, CRE could be a factor that suppresses the pace of recovery. As the recovery develops, the CRE problem will be a headwind, but not a show stopper, in my view.

What does "extended period" mean? I don't want to put a date on it. To me, it means the policy rate will be kept low until recovery has shown momentum that is based on private business and consumer demand, job growth is established or at least imminent, and the downside risks appear to be safely navigable.

Earlier today, the Fed announced an increase in the primary credit rate. The primary credit rate—also called the discount rate—is the rate at which the 12 Federal Reserve Banks across the country provide temporary liquidity to healthy banks. How should today's announcement be interpreted? I would not interpret this action as a tightening of monetary policy or even a sign that a tightening is imminent. Rather, this action should be viewed as a normalization step.

Because I hold to this forecast of modest recovery and believe inflation is likely to remain subdued, I fully support the message of the most recent FOMC statement to the effect that the fed funds target rate will remain exceptionally low for an extended period.

The FOMC met last week. In that meeting the federal funds rate target was kept at the "low as it can go" range of 0 to 25 basis points. Also, the Committee, in its post-meeting statement, said that economic conditions are "likely to warrant exceptionally low levels of the federal funds rate for an extended period." This policy is obviously very accommodative, and, in my opinion, is appropriate for a recovery that is tentative and facing headwinds.

A realistic level [for unemployment] might be above the [4.5%] level I saw when I joined the Fed. I do believe the structural rate of unemployment has risen. Calibrating monetary stimulus to a goal of bringing unemployment fully to prerecession levels would be a mistake.

Despite the lack of evidence of current inflationary pressures, some have expressed concern about the potential inflationary consequences of the Fed's very aggressive monetary measures taken in response to the financial crisis and recession... I am very confident that the Federal Reserve will be able to manage the normalization of its balance sheet with appropriate timing and pace. I do not expect inflation to change the course of economic recovery over my forecast horizon.

[E]ven if interest rates were at 1%, that would be extraordinarily accommodative [policy, although when it comes to rate hikes] I don't necessarily think we are ready for that.

The topic of the Atlanta Fed's annual financial markets conference this year is "Up From The Ashes: The Financial System After the Crisis."

Lockhart admitted that the title had been chosen earlier this year when, he said "we didn't anticipate fully Europe's sovereign debt troubles."

What's more, "We didn't predict the (Icelandic) volcano, so I'm not quite sure what ashes we're talking about," he joshed.

[I]t's realistic to assume we can't achieve perfect symmetry between the public being at risk and private gain

I continue to support the current stance of interest rate policy. But the time is approaching when it will be appropriate to consider recalibrating interest rate policy. I do not believe that time has yet arrived. The conditions that require a change of policy are not yet at hand. However, as the economy continues to improve and financial markets find firmer ground, extraordinarily low policy rates will not be needed to promote recovery and will become inconsistent with maintaining price stability.

The implication is that the policy rate may have to begin to rise even while unemployment is considerably higher than before the recession. I'm very concerned about unemployment, and certainly employment trends should be a critical consideration in setting policy. But I accept that good policy, even in circumstances of unacceptable levels of unemployment, may incorporate higher interest rates.

"I don't think that time has come yet" to raise rates, and to advocate for such an action in light of current economic circumstances is "premature," Dennis Lockhart said.

[A] recovery of the national economy is proceeding but not yet with solid and sustainable underpinnings. Inflation appears restrained. The outlook from here is beset by somewhat more than normal uncertainty. There is a chance of overachieving forecasts of moderate growth and gradual reduction of unemployment, but at the same time there are notable risks. In my view, these circumstances suggest caution in moving away from policies designed to give the economy the best possible prospect of recovery with full employment. Adjustment of monetary policy will be needed eventually, but this is not the time.

...[A] small precautionary action to avoid any risk associated with inadvertent tightening was prudent, in my view, in the midst of disappointing economic indicators.

That is how I interpret the decision announced following the August meeting—a small tactical change designed to preserve the level of liquidity provided to the system. I supported the committee's decision, but I do not view it as a fundamental change of outlook or strategy. I do not believe this change necessarily heralds the beginning of a period of further expansion of the Fed's balance sheet. Nor do I think the decision precludes a return to a policy of allowing the balance sheet to shrink on its own.

I think the decision has been over-interpreted in some quarters. These interpretations, along with alarmist commentary about deflation and a double-dip recession, are feeding an exaggerated sense of foreboding.

If action is taken by the Fed, a clear option is to grow the size of the balance sheet since the policy interest rate, for all practical purposes, cannot go any lower. Growth of the balance sheet would be accomplished by a second round of asset purchases (probably Treasury bills and notes) paid for by newly created money.

[A]nother round of monetary stimulus at least would provide some certainty that the central bank is on the job and intends to take the necessary action to avoid [possible deflation].

I am leaning in favor of additional monetary stimulus while acknowledging the longer-term risks the policy may present. At this juncture, and given the circumstances of sluggish growth and measured inflation that is too low, I give greater weight to the risk of further disinflation leading to deflation. In my mind, QE2 is a form of risk management—an insurance policy that is prudent to put in place at this time.

I am also open to a move that I believe would strengthen the effect and compensate for potential risks of the policy action—that move is the adoption of a more explicit inflation objective by the committee. I believe doing so might serve as a further step to ensure the anchoring of public expectations about long-term inflation and the response of the FOMC to adverse price developments. I consider a more explicit inflation target as something the public could easily understand, and I believe it would reduce uncertainty at a time when it is badly needed.

Today I will talk about an economic policy issue that, similarly, has been reduced to shorthand: QE2. This is not the famous luxury ocean liner; QE stands for quantitative easing, and the "2" denotes a second round of this policy activity.

...

Today I will walk you through the thicket of considerations that lead me, at this moment, to be sympathetic to more monetary stimulus in the near future. I take this view with a measure of tentativeness. Some more economic data will be posted before the next meetings of the FOMC in early November and mid December, and, as I always do, I would factor in the deliberations of the committee in the meeting before arriving at a final view.

It doesn't make sense to do a small portion of QE... It has to be enough to make a difference. Something along the lines of $100 billion a month would be in range.

I think it's important that we be measured in our expectations about how much further stimulus can accomplish in the current environment. I don't have outsized expectations. I see it as a precaution aimed at reducing or eliminating downsides. Further, in terms of near-term economic activity, I see the additional asset purchases as buttressing the ongoing effects of policies that have already been put in place. I expect it should have some incremental positive effect on overall demand. Also, it should reinforce, and accelerate somewhat, the growth momentum that is currently evident and, in my opinion, counter to some extent the strong headwinds the economy is facing.

According to Bloomberg News: 

Lockhart told reporters after the speech that his "working assumption is that the Fed "will in all probability complete the program in the eight months it's been designed for."

"we will be reviewing it at essentially ever FOMC meeting," he said.  "I wouldn't totally eliminate the possibility that there will be a mid-course change in direction".

The drag of uncertainty on economic activity persists as we enter 2011. That said, I would argue that the pall of uncertainty has lifted somewhat, and improved visibility could encourage more business risk taking and consumer spending.

Inflation is currently measured at lower-than-desired rates. A few months ago, fear of deflation was justified, but recently this concern has abated and the rate of inflation seems to have stabilized. Concern about inflation is rising because of higher gasoline prices and higher commodity prices, including food commodities. We are hearing stories that businesses incurring higher input costs may try to pass them through to retail prices. Higher input costs have not, however, translated to broad inflation of consumer goods and services. And, importantly, longer-term inflation expectations have stabilized in a healthy range. Through 2011 and 2012, I expect gradual firming of underlying inflation pressures from current very low levels to healthier levels.

Improvement in the labor market has lagged broader economic recovery... I expect the unemployment rate to fall over the coming years, but I think it unlikely that jobs growth this year will be strong enough to generate quick improvement.

``{Tapering} is certainly a pertinent topic but my working assumption is the schedule of purchases as stated is going to be held to closely.''

``My working assumption is we will carry through with the full scale of the program over the time frame we laid out, which is through June.''

In response to a question about about whether the Fed would consider tapering off its $600 billion purchase program

I want to contrast inflation to the cost of living. In casual language, we often interpret a rise in the cost of living as inflation. They are not the same thing. Cost-of-living increases are a result of increases in individual prices relative to other prices and especially relative to income. These relative price movements reflect supply and demand conditions and idiosyncratic influences in the various markets for goods and services. If some component of a household's cost-of-living basket goes up in price, the higher cost of living is not ipso facto inflation.

...

The Fed, like every other central bank, is powerless to prevent fluctuations in the cost of living and increases of individual prices. We do not produce oil. Nor do we grow food or provide health care. We cannot prevent the next oil shock, or drought, or a strike somewhere —events that cause prices of certain goods to rise and change your cost of living.

I have no intention of supporting, under political pressure, the monetizing of the debt.. [That would be] a central banker’s cardinal sin.

Lockhart said it would be “wise” to complete the Fed’s planned $600 billion of asset purchases as scheduled under the program aimed at boosting U.S. growth.

Not many weeks ago I was ready to say—as regards growth prospects—that I could be pleasantly surprised to the upside. The economy might grow faster than my assumed moderate pace, with unemployment coming down more quickly. I still hold to the view that I could be pleasantly surprised but with a touch more caution... The range of plausible scenarios is widening. A sober assessment of prospects for continued economic progress has to factor in not only the risk of a sustained oil shock but also risks associated with fiscal policies and politics both here and in Europe.

Lockhart said he disagreed with the view that the central bank should extend its Treasury purchases into the third quarter at a slower pace, a “tapering” approach similar to how the Fed ended an earlier program to buy mortgage-backed securities.

“I wouldn’t totally rule it out, but I don’t think it gains a lot,” he told reporters. “The amount of purchases is manageable within the markets, and the markets understand this program runs through June. So I don’t see a lot of gain to reverting to a tapering approach.”

As reported by Bloomberg News

Today is likely the last day you will hear from FOMC policymakers for a few days. FOMC participants generally refrain from speaking publicly about the macroeconomic outlook and near-term monetary policy the week before meetings—and our next meeting is a week from tomorrow.

It's also worth mentioning that my staff and I don't rely exclusively on the data to form our opinions. Because the Sixth Federal Reserve District is a pretty significant portion of the national economy and resembles the nation overall in industry composition, we go to great lengths to generate grassroots economic intelligence that supplements our analysis of the incoming data.

I want to highlight the analogous character in practical effect of traditional monetary policy using interest rates and the less familiar asset-purchase tools we have employed since the federal funds rate hit its lower bound. Though some have argued otherwise, I believe the FOMC hasoperated for at least a decade with a consistent and fairly well understood rules-based framework. It is within this framework that I think about the desirability of both LSAP3 and the inevitable exit to a less accommodative policy stance.

...

Even though I personally am not expecting an immediate need to implement an exit, I think it's fully appropriate to revisit the implementation assumptions and tools readiness. As I contemplate an exit, two basic and obvious questions come to mind—when will it be appropriate to undertake an exit, and how to implement the exit.

...Since I think passive unwinding is probably not feasible, we will have to decide when to actively implement an exit strategy. And though the answer to when to do this is clear in concept, it is not straightforward in practice. Lags in the effects of monetary policy mean that action generally needs to be taken in advance of definitive changes in the path of economic activity and prices. That is why the policy framework I am describing emphasizes a forward-looking rule-like construct to which the FOMC would simply react.

With the information I have today, my first inclination is to be very cautious about extending asset purchases after June. Given the emergence of new risks, however, I prefer a posture of flexibility as regards policy options. As we have seen, conditions can change rapidly, so I will continue to evaluate the incoming information as much as possible with fresh eyes as I approach each meeting and each decision.

Finally, as an element of a framework for the near term, I want to push the notion of a renewed focus on monetary and credit aggregates. The anxiety about the large size of the Fed's balance sheet revolves around fear that reserves currently idle on bank balance sheets will suddenly come off the sidelines. If those balances get in the game faster than the economy can absorb them, there might be serious inflationary consequences.

Practically speaking, I find it hard to imagine circumstances in which the credit channel would heat up so fast and in such volume that broad money creation would get away from the Fed's capability to drain liquidity. But precautionary monitoring is certainly warranted.

In recent history, there has not been much attention put on monetary aggregates. I would argue this is not because economists and policymakers have abandoned belief in the fundamental long-run relationship between money and inflation. Instead, monetary measures have not factored into policy discussions for quite some time because fluctuations in money multipliers and velocity made broad measurement elusive. Financial innovation has been such a force that forecasting methodology based on the money-price level growth connection came to be viewed as unreliable for policymaking.

It's worth remembering, however, that it was Paul Volcker's return to a focus on money growth that led the way to defeating the Great Inflation. The Volcker Fed's success set the stage for an extended period of controlled inflation approaching three decades.

[C]ontrary to popular opinion, Federal Reserve officials do actually eat and fill up their gas tanks. The FOMC's mandate, as I see it, is to control the inflation rate we all experience—so-called headline inflation. In other words, I interpret the Fed's price stability mandate as requiring the FOMC to manage the growth rate in the average of all prices, including food and energy.

... it's our job to control that headline inflation over the course of time. It's not feasible to exert such control day-to-day or month-to-month or even quarter-to-quarter. But monetary policy can control the rate of overall inflation over the medium term. In operational terms, I think growth in overall consumer prices around 2 percent per year through a period shorter than the proverbial "long term," say, a medium-term period of three or four years, is consistent with the Fed's price stability mandate.

While short-term measures of inflation have moved up rather strongly in the last few months, I hold to the view that this trajectory will not persist. I continue to see the Federal Reserve's inflation objective I just outlined as attainable.

While short-term measures of inflation have accelerated in the last few months, I hold to the view that this trajectory will not continue. I continue to see the Federal Reserve's inflation objective I just outlined as attainable.

That said, like my colleagues on the FOMC, I continuously monitor performance against our price stability objective. This involves monitoring not just inflation today but importantly the course of inflation expectations, whether derived from surveys or pulled from financial market prices. I am prepared to support a change of policy if evidence accumulates that the low and stable inflation objective is at risk.

[L]ke my colleagues on the FOMC, I continuously monitor performance against our price stability objective. This involves monitoring not just inflation today but importantly the course of inflation expectations, whether derived from surveys or pulled from financial market prices. I am prepared to support a change of policy if evidence accumulates that the low and stable inflation objective is at risk.

In banking and a number of other industries, many contacts across the Southeast region of the country are increasingly giving voice to claims that this re-regulation is overreaching and potentially destructive. I frequently hear—across a range of industries—that the growing cost of compliance will drive out investment and hiring. As a current banking supervisor who has a background in the private sector, I see both sides of this concern. Let me just say that, to maximize the economy's potential, I believe that in the coming years we need to strike the right balance in all regulated sectors.

I wouldn’t rule it out entirely, but at this stage I personally am not leaning in the direction of thinking [raising rates by year-end] is absolutely required.

I don’t think we reverse that commitment [to complete our asset purchase program by the end of June] or change that commitment without some very compelling reasons to do so. I don’t see those conditions existing at this time. My outlook also doesn’t anticipate such a rapid change in conditions that a change in policy is required at this time.

My view of the future permits a degree of patience as regards monetary policy. There is still a halting and fragile quality to the economy. I think the process of restoration of full economic strength with higher employment continues to require support. That said, planning for an eventual change of course is completely appropriate as long as public discussion about planning deliberations and the plan itself don't create premature expectations of tightening.

Lockhart, who has voiced support for the central bank’s plan to buy the $600 billion of Treasuries, said that so far “the economy seems to be absorbing that higher cost [of oil prices] without severe reaction.” If oil prices top $150 a barrel for a sustained period, “it could have a more serious effect,” and “we could be in recessionary territory,” he said.

“There’s a very high bar [for another round of assets purchases] in my opinion” for a new program, Lockhart said.

“A high bar doesn’t mean totally impossible,” he said. “The way the economy is evolving simply suggests to me that further stimulus of any large magnitude, along the lines of what you would imagine a QE3 program would be like, is simply not going to be necessary.”

Let me offer a few general thoughts about what would make for an effective inflation target.

First, it would be stated in terms of some measure of overall, or headline, inflation.

Second, the target must be achievable over a realistic timeframe. That time horizon should be short enough to serve the real interests of the public and short enough to serve as a verifiable check on central bank performance.

But since monetary policy actions do not have an impact on the economy instantaneously, the time horizon should be long enough for the objective to be realized at an acceptable cost. I also accept that there will be times we must allow short-run deviations from the targeted rate of headline inflation, and the stated objective should be constructed with this in mind.

I do not think the establishment of an inflation target would produce much change in how the Federal Reserve conducts policy. We have been pursuing policies with an eye toward 2 percent or slightly less headline inflation at least since we began publicly reporting our longer-term inflation forecasts.

There is a very high bar to another round of asset purchases and my forecast for the economy really would not need another round.

I don't think QE3 will be necessary. I think we're going to see this modest, moderate but continuing pace of growth that doesn't require further stimulus. Secondly, the stance of policy is at the moment very stimulative. Simply maintaining that stance of policy for some period of time should be sufficient support for a continuing recovery. I would also have concerns about diminishing returns to further stimulus when many of the headwinds to growth are not fundamentally addressable by monetary tools.

“I don’t think you want to take any policy option off the table,” he said. At the same time, “There is a high bar to do another round of quantitative easing.”

If, however, I come to conclude that we're in a world that portends a long period of very weak growth, high unemployment, and painful structural adjustment, the much-anticipated policy normalization may have to be rethought. The FOMC, in my view, may have to define a supportive policy stance that will be held in place for quite a long period while letting what are essentially nonmonetary policy fixes do their work. Among the nonmonetary fixes are policies to address labor market gaps and fiscal rebalancing implemented over a number of years.

If additional actions are required, I can assure you the Federal Reserve is not out of bullets. If the anemic growth in the first half of this year is a soft patch in an ongoing, moderately paced recovery, additional monetary stimulus is probably of limited marginal value. But saying this is not the same thing as saying that monetary policy would be ineffective if conditions deteriorate. Expansion of the balance sheet or changes in the composition of the Fed's asset portfolio are available, in my view. These could be quite effective, particularly if done in sufficient size, in the event that the economy retreats back into contractionary territory.

“Given the weak data we’ve seen recently and considering the rising concern about chronic slow growth or worse, I don’t think any policy option can be ruled out at the moment,” Lockhart said today a speech in Lafayette, Louisiana. “However, it is important that monetary policy not be seen as a panacea.”

“We may find, as economic circumstances evolve, that policy adjustments are required,” Lockhart said to the Greater Lafayette Chamber of Commerce. “In more adverse scenarios, further policy accommodation might be called for. But as of today, I am comfortable with the current stance of policy, especially considering the tensions policy must navigate between the short term” and longer structural adjustments.

Lockhart said in response to audience questions that the central bank should have a significant impact through its pledge to hold interest rates low through at least mid-2013, while the commitment may change should the economy gain strength.

The central bank’s pledge “should have a big influence on the market,” Lockhart said. “Even that is conditional to an extent” and “could be revisited,” he said. “For the most part, we can count on it.”

Lockhart also said the Fed has other options to provide stimulus, such as cutting the interest rate it pays banks for their reserves held at the central bank, although he noted that is a relatively small thing and not a big economic influence.

“Persistent unemployment may be more attributable to a slowdown in the hiring rate than a rise in job destruction and job loss,” Lockhart said today in Atlanta, citing a research paper. “A hiring slowdown can be viewed as consistent with a structural problem, a mismatch problem.”

The conditions in which we would invoke another round of large-scale asset purchases should be pretty demanding conditions, conditions of a really marked deterioration in the economy, perhaps some rise in unemployment, and, or deflationary trends developing.

An additional large-scale asset program isn’t warranted because there is no risk of falling prices, unlike last year, Lockhart told reporters.

“It requires circumstances we are not facing at the moment -- that is, the onset of a recession, deflationary pressures and seriously rising unemployment,” he said.

There is a very high bar to resorting to the policy of further quantitative easing

At this time my notion of "appropriate monetary policy" is one of holding steady the current policy rate (federal funds rate) of zero to 25 basis points and the balance sheet steady at current scale. I supported efforts to put pressure on longer-term interest rates for the modest additional stimulus that might produce. That said, I am skeptical that further asset purchases will produce much gain in terms of increased economic activity. I don't believe further bond purchasing by the Fed is a potent policy option given the set of circumstances we currently face. But that is not to say that such a policy action would not be powerful and appropriate in other circumstances, and I don't think any option should be taken off the table.

Speaking for myself only, steady even if unspectacular growth accompanied by inflation in the neighborhood of 2 percent justifies some reluctance to change, in either direction, the FOMC's accommodative policy. At the same time, I think slow progress toward full employment justifies continuing consideration of whether more can and should be done. So for me as a policymaker, now is not a time to lock into a rigid position.

I think slow progress toward full employment justifies that we continue to consider whether more can or should be done. So for me as a policy maker, as I enter this year, now is not a time to lock into a rigid position.

I think the current policy stance is appropriate for an outlook of steady, moderate growth with gradual employment gains. I do not see this accommodative policy compromising the objective of 2 percent inflation.

At the moment, I favor a policymaking posture I'd call "vigilant restraint."

I recently heard the analogy of a clogged drain in a kitchen sink. The speaker posed the question of whether the Fed should push on the blockage by running the water more intensely or instead put on a rubber glove, reach down, and pull the stuff out. Even the normally technical discussions of monetary policy can have a "yuck" factor from time to time.

I think a realistic assessment of the challenges associated with closing the employment gap call for sustained extraordinary support for what is, like it or not, a gradual process. At the same time, I'm cautious about doing more involving expansion of the Fed's balance sheet. Precisely because I see the transmission mechanism of monetary policy through credit channels as constricted, I have my doubts that the gains from such a policy action taken in the near term would outweigh the longer-term potential costs, including the risk to the Fed's medium-term inflation outlook.

Lockhart commented further in the Q&A session:

If there were to be "an onset of recessionary conditions and a movement in a deflationary" direction, Lockhart said "we would have to consider further balance sheet kinds of stimulus."

Alluding to earlier remarks about the normal credit conditions -- or the "monetary transmission mechanism" -- being "clogged," Lockhart said "a second conceivable possibility" that could lay the groundwork for QE3 would be "more receptive conditions (in credit markets) combined with a clear need of some kind." If credit channels were to become less clogged in a situation where economic and financial conditions otherwise seemed to call for QE3 then "if we do something it would have a measurable effect," he said.

I am at the moment in a position that I’ve called essentially patient vigilance–meaning that I want to see how the economy evolves before drawing conclusions that more stimulus is needed and could actually have the effect where the benefits would outweigh the costs. I don’t rule it out.

Lockhart said the Fed’s pledge to keep rates low through late 2014 “is very much dependent on the outlook” though currently “aligns with the outlook I see.”

“Almost two years after the Dodd-Frank act became law, many rules have not yet been written so much of the detailed work still lies ahead,” Lockhart said, referring to the law intended to reform banks and financial firms in response to the crisis. “The details of the rules will influence the structure of the firms” and the financial sector overall.

Lockhart also said that he remains comfortable with the Fed's conditional pledge to keep interest rates very low through late 2014, saying the language "is still broadly aligned with the reality of the economy and the forecast."

Lockhart, who votes on the FOMC this year, reiterated his view that he’s “skeptical” additional bond buying by the central bank would strengthen the recovery.

“Circumstances today in the United States call for continued measured efforts to quicken the pace of recovery and shrink unemployment, while keeping inflation controlled and close to the FOMC’s official target of 2 percent,” Lockhart said. “Those efforts for the time being should fall in the realm of communications.”

“As popular as it might be in some quarters to rule out” a third round of so-called quantitative easing, “I do not think this option can be taken off the table,” Lockhart said today in Tokyo. “QE3 will work under the right circumstances. But I don’t believe such circumstances prevail at this time.”

“I currently judge the risks to the U.S. outlook as tilted modestly to the downside,” Lockhart said today in a speech in Hong Kong that repeated remarks by him in Tokyo yesterday. “Chief among them is the potential for broad spillover from Europe to the U.S. and global economy resulting from financial system disruption as well as further economic slowdown.”

The May employment report, combined with downward revisions to the March and April jobs statistics, was clearly a disappointment. There remains some question about the degree of weather-related payback from the robust job growth earlier in the year. Losses in construction jobs, for example, were unexpectedly large in May. But it is nearly impossible to escape the conclusion that we are replaying in some manner the spring-summer slowdowns of the past two years.

It is my sense that material risks to the economic outlook are gathering, so it is worthwhile to spend some time talking about risks in some detail.

...

However, as the employment report of last Friday illustrates, there continues to be a halting and tenuous character to the recovery.

Looking ahead, my viewpoint as regards further policy measures considers two possibilities. Should it become clear that something resembling my baseline scenario of continued, though modest, growth is no longer realistic, further monetary actions to support the recovery will certainly need to be considered.

In addition, the situation we face requires that the FOMC maintain a state of readiness to respond to financial or economic instability should the need arise. I am confident that the committee retains the capacity to act and the tools to promote stability.

Importantly, the economy itself is in a better condition to withstand threats to stability than it was at the time of the financial crisis in 2008 and 2009. I still think it is prudent to acknowledge a degree of fragility, but in its fundamentals, the U.S. economy has made substantial progress toward resilience.

Federal Reserve Bank of Atlanta President Dennis Lockhart said extending Operation Twist, the program to lengthen maturities of debt on the central bank’s balance sheet, is an “option on the table.”

“There is capacity to do more,” Lockhart said today in response to audience questions after a speech in Fort Lauderdale, Florida. “It is certainly an option. I’m not going to speculate on what the FOMC will do,” he said, referring to the Federal Open Market Committee.

Lockhart, when asked about remaining policy tools that could yet boost the slow and shaky U.S. economic recovery, said: "I am simply not of the view that we have exhausted all of our options.

"I think there are monetary policy tools and actions that are still available if the conditions require them."

The indicators of economic strength so far in 2012 have been underwhelming. I expect the recovery process to be slow and drawn out. I think the most reasonable expectation is moderate growth, a slow and possibly halting decline of unemployment, with inflation staying close to 2 percent.

---

Lockhart told reporters after his speech he was going into next week’s FOMC meeting with an “open mind” to review the Fed’s “very thorough” staff analysis and other participants’ views, though he was not ready to back additional action today.

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"I don't think any of the options should be taken off the table under the current circumstances. But I'm not convinced at this moment that the circumstances quite yet call for additional action," Lockhart told reporters.

“I don’t think any of the options should be taken off the table under the current circumstances,” Lockhart told reporters after the speech. “But I am not convinced at this moment that the circumstances quite yet call for additional action.”

Atlanta Fed President Dennis Lockhart, in an interview with Dow Jones Newswires, said that when it comes to additional Fed action, "I simply do not rule it out. It is an option that is open depending on how things evolve."

"I am more leaning toward the view further action would be a response to deteriorating conditions and a deteriorating outlook that could be conceivably caused by financial instability that might have an external source,"

[A]s the year has unfolded, my colleagues and I at the Atlanta Fed have recalibrated our risk evaluation. While not fully factored into our baseline outlook, we're acknowledging darker possibilities. Risks associated with developments in Europe, the so-called fiscal cliff here in the United States, and a global economic slowdown have weighed more heavily on our outlook.

All 19 FOMC participants submit forecasts for GDP growth, inflation, and employment four times each year. The central tendency for 2012 GDP growth dropped from a range of 2.4 to 2.9 percent in April to a range of 1.9 to 2.4 percent in June. In my view, this was a rather abrupt and material adjustment to the outlook.

In recognition of this change of outlook, the FOMC decided last month to extend the so-called Operation Twist program until the end of 2012.

It's possible another policy decision looms. My colleagues and I on the FOMC may confront a decision on whether or not to respond more aggressively to the economy's apparent weakness.

I think the stakes in the policy discussion around the FOMC table today are very high.

[M]y support for the current stance of policy rests on a forecast that sees a step-up of output and employment growth by year-end and into 2013. If the economy continues on the track indicated by the most recent incoming data and information, that forecast will become untenable, as will the policy premises underlying it.

Some recent homeowner programs have tried to eliminate barriers to refinancing and have helped. For example, I hear from bankers that the second version of the Home Affordable Refinancing Program, or HARP II, appears to be quite successful in helping homeowners who are saddled with negative equity and mortgage rates well above the current market rates.

It's possible another policy decision looms. My colleagues and I on the FOMC may confront a decision on whether or not to respond more aggressively to the economy's apparent weakness.

There is a risk to monetary policy being employed too aggressively and without effect to address economic problems that can be resolved only by fiscal reforms that involve making tough choices about the allocation of public resources. Monetary policy can exert a powerful positive influence on an economy, but as Chairman Bernanke has pointed out, monetary policy is not a panacea.

When asked about the prospect of a third round of bond buying from the Fed, Lockhart said it was a "close call." However, he laid down a marker for how weak the economy would need to be before the central bank might act.

"If we were to see deterioration from this point, let’s say a persistence of job growth numbers that were well below 100,000 per month, or see signs of disinflation that could signal the onset of deflation, then there wouldn’t be much of a question about policy," Lockhart said.

Growth in 2013 will pick up from this year’s pace, while the risks associated with the central bank’s new asset-purchase program will be "manageable," Lockhart told reporters after the speech. The district bank chief said he would like to examine the state of the economy before deciding what policy would be appropriate once Operation Twist ends.

As reported by Bloomberg News

I have been persuaded that the problem [of persistently high unemployment] is, to a significant enough extent, one of weak growth that can be ameliorated by prudent monetary policy actions. A stronger overall pace of recovery is central to improvement in the labor market.

Lockhart told reporters after his speech he was skeptical about a proposal made yesterday by Minneapolis Fed President Narayana Kocherlakota that the central bank should hold interest rates at around zero until unemployment drops below 5.5 percent.

“My comment on that is 5.5 percent is much closer to current measures of full employment,” Lockhart said. “I am not so sure that it will not be appropriate to begin the process of tightening before we would get to what we would consider full employment. I don’t want to rule out that could be the case.”

Remember that at the beginning of my remarks I characterized my thinking on the meaning of "substantial improvement" as a work in progress. In that spirit, let me share a qualitative framework for defining "substantial improvement."

The starting point certainly should be the headline unemployment rate and the payroll jobs number. The interpretation of movements in these two statistics would be enriched and reinforced by a review of additional data elements.

Here are examples of what I would look for:

First, I would look for lower unemployment rates that are driven by increased flows of job seekers into employment. I would not interpret discouraged workers dropping out of the labor force as a sign of improvement, even if the unemployment rate falls as a consequence.

Conversely, I'd like to see growing public confidence in the labor market as measured by increased movement of people from out-of-the labor-force status into the labor force—that is, growing labor force participation. I would interpret a reduction in the number of marginally attached workers as a sign of improvement, even if the unemployment rate goes temporarily higher.

Third, I'd look for employment gains that are associated with reductions in underemployment. I would interpret a pickup in job growth less positively if it is associated with increases in part-time jobs for people who seek full-time work.

Finally, I'd like to see signs that improvements in all these indicators are gaining momentum and are sustainable. A framework for assessing labor market conditions needs to include forward indicators of labor market health, such as falling claims for unemployment insurance.

The central bank need not make a “direct, targeted” response to the disaster because any harm to the U.S. economy would be transitory, Lockhart said. "That impact is likely to pass and therefore it is not necessarily something that monetary policy can or should address.”

Lockhart said “it would not surprise me if there is a measurable fourth quarter effect” on growth from Sandy, given the large population of the Northeast. Rebuilding after the storm could be “a form of stimulus.”

But these calculations may underestimate the true magnitude of the problem. A funding ratio of 75 percent equates to an assumption of an 8 percent average annual return on the portfolio of investments. It's fair to ask whether this is a realistic assumption given current forecasts of the economic and financial environment. Arguably not.

Using this optimistic 8 percent return assumption, public state and municipal pension funds have an $800 billion funding gap to fill. Using a lower, more realistic return assumption (such as the longer-term rate on U.S. Treasuries) implies a $3 trillion to $4 trillion funding gap. You might call this "the other debt problem" in the United States.

A real financial stability concern, however, is the potential for malicious disruptions to the payments system in the form of broadly targeted cyberattacks. Just in the last few months, the United States has experienced an escalating incidence of distributed denial of service attacks aimed at our largest banks. The attacks came simultaneously or in rapid succession. They appear to have been executed by sophisticated, well-organized hacking groups who flood bank web servers with junk data, allowing the hackers to target certain web applications and disrupt online services. Nearly all the perpetrators are external to the targeted organizations, and they appear to be operating from all over the globe. Their motives are not always clear. Some are in it for money, while others are in it for what you might call ideological or political reasons.

What can policy, broadly speaking, do to foster growth, innovation, and job creation? At a high level, three things. First, policymakers can remove obstacles to growth—for example, uncertainty regarding the fiscal path of government, policies that discourage new business formation, and disincentives to invest. Second, and the mirror image of obstacles, is positive, pro-growth policies. Examples include investment in human capital and critical infrastructure.

And finally, there is a role for monetary policy. In my view, monetary policy can deliver appropriately favorable interest rate conditions, always in a context of low and stable inflation. Monetary policy plays a critical role in creating the most favorable conditions for other policy actions to do their work.

The Federal Reserve will likely have to continue with its bond buying efforts into the second half of this year but needs to watch out for the possible formation of asset price bubbles, a key central bank official said Tuesday.

"It's something we have to watch out for, particularly for reasons of financial stability," Federal Reserve Bank of Atlanta President Dennis Lockhart told journalists after giving a speech in the Spanish capital.

Mr. Lockhart, who isn't a member of Federal Open Market Committee this year, said there are currently no signs that asset price bubbles are forming. He said that some have pointed to the recent rise of the value of farm land and stock markets as evidence that these assets are no longer rationally valued. "I don't think you can make that claim," he said. "But I think the recent history of our housing bubble suggests we have to be vigilant about that."

As reported by Dow Jones News

I do believe that we're not going to see enough improvement in the very short term to claim victory on the substantial improvement idea, and therefore my recommendation would be to continue {asset purchases} through the end of the second half {of the year}.

There are encouraging developments in the economy, to be sure, but the evidence of sustainable momentum that will deliver “substantial improvement in the outlook for the labor market” is not yet conclusive. I favor a “wait and watch” mode for the time being. Several more months of positive data—especially in a range of employment data—would give me confidence that the economy has real traction and is unlikely to backslide.
…

The key word in the phrase “substantial improvement in the outlook for the labor market” is outlook. For my part, a critical consideration in judging how much longer asset purchases should continue will be confidence in the positive outlook. Confidence that is solidly grounded in improving economic data, accumulated over a sufficient span of time, will help me conclude that the work of the large-scale asset purchase program, as a temporary supplement to conventional interest-rate policy, is complete.

The decision to curtail asset purchases ought to be forward-looking, and in my judgment, that point could come later this year or early next year without harm to the momentum of the economy.

“I have not seen enough evidence yet to convince me that 2013 is going to break out of that pattern that we’ve seen, really over the last four years,” Lockhart said. He predicts “a modest pace of growth, inflation that is pretty well contained and a very gradual reduction in unemployment.”

I think we are approaching a period in which {asset purchase cutbacks} can be considered... Thats not to say June meeting, but we are approaching a period in which it can be seriously considered based upon sort of the momentum of the economy which is not great but nonetheless is moving forward.

As the Chairman made clear, there is no "predetermined" pace of reductions in the asset purchases, nor is the stopping point fixed.

The pace of purchases, the composition of purchases, and the ultimate size of the Fed's balance sheet still depend on how economic conditions evolve. All elements of the asset purchase program will be considered on a meeting-by-meeting basis in light of the incoming data and economic outlook.

In my view, the comments by the Chairman do not constitute an enormous shift in policy. The asset purchase program is best thought of as a supplement to the FOMC's interest rate policy, designed to add a little more heft to efforts in support of ongoing recovery. As I said a moment ago, I still anticipate that the very low interest rate policy will remain in place for a considerable time after the end of asset purchases, and thus policy will remain highly accommodative.

...

If the broad economy evolves close to the outlook I laid out—which itself is close to the composite forecast of the 19 FOMC participants—then the economy will be on track to a better place. In that circumstance, I think the position that the economy does not need quite as much stimulus is fully supportable.

“If we see the growth pick up in the second half and if we see job gains ... at a higher range, say 180-200,000 – I think with other fundamentals improving we probably are in a position to remove ... the extraordinary policy program over the medium term,” Mr Lockhart said in an interview with Market News International.

But Mr Lockhart noted that the timing of slower asset purchases would depend on the incoming economic data. “[With a] kind of ambiguous picture of mixed data that signal neither accelerating strength nor necessarily deterioration, but that kind of moping along in the middle, then I think it’s not a foregone conclusion that the asset purchase programme should be removed or be removed rapidly,” Mr Lockhart added.

As reported by The Financial Times.

As of September, the FOMC will have in hand one more employment report, two reports on inflation, a revision to the second-quarter GDP data, and preliminary incoming signals about growth in the third quarter. I don't expect to have enough data to be sure of my outlook. For that reason, I don't think a decision that commits the Fed to a full phase-out of asset purchases and lays out a precise, beginning-to-end path for doing so would be advisable.

In my mind, the first adjustments to asset purchases, when they occur, should be the beginning of a process with steps that will be determined as later information arrives and certainty about the direction of the economy accumulates. As I see it, a decision to proceed—whether it is in September, October, or December—ought to be thought of as a cautious first step.

Policymaking is quite appropriately forward-looking because monetary policy actions affect the economy with a lag. The rolling outlook from here is what really matters in making future decisions on asset purchases. I will need to get comfortable that the employment progress we've enjoyed is not stalling and that disinflation pressures are not building.

All that said, in considering a decision to reduce purchases, I think it is important to acknowledge the progress that's been made since the launch of QE3. The most recent program of asset purchases has been in force for just short of a year. In August a year ago, the unemployment rate stood at 8.1 percent. A year later, the unemployment rate has fallen to 7.4 percent and monthly job gains, looking back over the year, are averaging just below 200,000. Consumer activity has grown, house prices and housing activity have picked up, and equity markets have shown strength.

We have continued to see steady progress in economic fundamentals, in my opinion. Progress is evident, and we should not lose sight of that.

“I would be supportive in September as long as the data between now and then basically confirm the path we’re on,” Lockhart, who doesn’t vote on monetary policy this year, said today in a CNBC interview from Jackson Hole, Wyoming. “I am confident in a continuation of this sort of moderate growth path.”

Since the early 2000s, however, the job reallocation rate has slowed...

Interpreting this apparent loss of dynamism across firms is not straightforward. It could be that these slowing dynamics are not a bad thing if we get the same growth of productivity we've enjoyed in the past without so much churning of jobs. But that doesn't quite fit with the low productivity growth we've experienced during this recovery.

…

The likely direction of productivity measures in our economy is the subject of considerable debate. Another, more concerning possibility is that the slow advance of productivity reflects a fundamentally less dynamic economy.

…

The question I posed at the outset was whether the economic dynamism of the United States is declining. Is America losing its economic mojo? There is some evidence to the affirmative. I believe some of what we observe can be explained by the recent recession and frustratingly slow recovery. There are reasons to believe that some of the decline is cyclical in nature and will reverse itself over time.

While the decision not to pull back on the Federal Reserve‘s easy-money policies last week was a “close call,” a veteran central banker on Monday suggested it will be hard for the Fed to find cause to trim its bond buying program at its upcoming October meeting.

In an interview with the Wall Street Journal, Federal Reserve Bank of Atlanta President Dennis Lockhart said the economy is currently beset with uncertainty resulting from economic data that’s proved “ambiguous.” At the same time, a showdown between the White House and the Congress over the budget and borrowing powers has the potential to cause economic trouble if it’s resolved as poorly as past episodes, the official said.

“In the short time between now and the October meeting, I don’t think there will be an accumulation of enough evidence to dramatically change the picture” about where the economy now stands, Mr. Lockhart said.

…

Mr. Lockhart said the October FOMC “is a live meeting” and if the Fed wants to act, it can and will. Still, he added, “I don’t have expectations that the fog will clear dramatically between now and October.”

I would not take off the table at least consideration {of tapering in December}.

“I would not take off the table at least consideration at that time,” Lockhart told reporters in Oxford, Mississippi, in response to a question on tapering in December. “The question of changing the mix of accommodative tools ought to be on the table at every meeting for the foreseeable future.”

“I would not take off the table at least consideration at that time. ” Lockhart told reporters in Oxford, Mississippi, in response to a question on tapering in December. “The question of changing the mix of accommodative tools ought to be on the table at every meeting for the foreseeable future.”

As reported by Bloomberg News

I’d like to see some movement toward the {inflation} target before tapering.

“I’d like to see some movement toward the target” before tapering, Lockhart said today in a Bloomberg Radio interview with Kathleen Hays. Inflation is “stable but too low” and a move up would “give me some confidence we are not dealing with some downside scenario that might develop,” said Lockhart, who doesn’t vote on policy this year.
…
The Fed must also communicate to investors its intent to keep policy stimulus even as it tapers, which could mean changing its communication of “forward guidance” on interest rates at the same meeting, Lockhart said.
“I would be supportive of consideration of that,” he said. “We might enhance the forward guidance to convince the public and the market that the environment is not going to change much” after a reduction in bond buying.

I now think it is appropriate in coming meetings to put a tapering decision on the table as long as the resulting overall posture of policy preserves a high degree of accommodation.

…

If and when the FOMC arrives at a decision to wind down asset purchases, it's my view that it will be helpful to the transition process to provide as much certainty as possible about how this will be done. The minutes of the October FOMC meeting noted that

[S]ome participants mentioned that it might be preferable to...announce a total size of remaining purchases or a timetable for winding down the program. A calendar-based step-down...would be easier to communicate and might help the public separate the Committee's purchase program from its policy for the federal funds rate and the overall stance of policy.

I am among those who see merit in this approach as long as the economy follows roughly the path we expect. Once the decision is made, I favor providing the public as much clarity and certainty as possible about how the change will be executed.

As I mentioned earlier, I think inflation will stabilize and begin to move back in the direction of the FOMC's 2 percent objective as the economy gathers momentum. So I'm interpreting the soft inflation numbers as a risk signal. Through the lens of prices, the economy could be weaker than we currently believe. I talk with a lot of business people across the Southeast. Very few claim to have much pricing power. At the same time, inflation expectationsmeasured by surveys and inflation-adjusted financial instrumentshave remained stable. There are no signs of disinflationary expectations being priced in. This gives me some confidence that inflation will firm.

The drop in joblessness poses a problem for the Fed's so-called forward guidance, Lockhart told reporters afterward. "I think the 6.5 percent (threshold) is not serving as well now as it may have served earlier when we were a fair distance away..." he said, "and it now requires substantially more explanation and for that matter more interpretation of what the number actually is signaling." Lockhart did not advocate lowering the threshold, as have some other Fed officials.

The drop in unemployment “reinforces the need to add some qualitative interpretation to the threshold or to find a different way to communicate,” he said. “It presents some challenges in communication” for the central bank.

Absent a marked adverse change in the outlook for the economy, I think it is reasonable to expect a progression of similar moves, with the asset purchase program completely wound down by the fourth quarter of the year.

Why was it that the banking system in this part of the country was, apparently, especially vulnerable, and what lessons can be drawn from this experience?

At the risk of some oversimplification, I'll propose four takeaways.

First, concentrations can be deadly. Many of the banks that failed, especially around Atlanta, were relatively young banks that became highly concentrated in residential real estate loans, particularly acquisition, development, and construction, or ADC loans.

Second, many of the banks that failed were excessively reliant on wholesale funding. The median wholesale funding-to-asset ratio of the Georgia banks that failed was 30 percent. Hot money can burn you.

Another factor that contributed to failures was inexperience with severe conditions along with overdependence on collateral values without an understanding of cash flows under various scenarios. I'm a former commercial banker. I was taught that cash generation repays loans, and analysis of the borrower's ability to repay is basic...

Finally, many of the failed banks suffered from weak governance. Banks need board members who understand their role as directors. Directors as a group set policy, define the risk appetite of the bank, and hold management accountable for risk management.

We are making progress on the full employment goalby some measures, like the rate of civilian unemployment, a lot of progress. The rate of unemployment fell to 6.3 percent last month and is closing in on levels that many believe to be consistent with a practical definition of full employment. But a number of other measures of labor market performance tell me that the economy is still operating well short of full employment. Notably, there remains an unusually high percentage of prime working-age people who are marginally attached to the labor force, who are working part-time jobs when they would prefer to be working full-time, and who are leaving the workforce. These indicators and others suggest to me that fulfillment of our employment mandate is still a ways off.

I've given you the broad strokes of a pretty optimistic outlook...

As confirming evidence, I'll be paying attention to consumer spending and consumer confidence. Data on both have been, on balance, encouraging. I'll be monitoring industrial activity closely. While the manufacturing production numbers stepped down in April following very strong gains in February and March, the April report from purchasing managers on production and orders was quite positive. And I'll be looking for sustained employment gains...

At any given juncture, absolute certainty of the economy's direction is not achievable. As I've suggested, I feel the need to see confirming evidence in the data validating the view that above-trend growth is occurring and is sustainable, and that the FOMC is closing in on its policy objectives. One quarter's data isn't enough. I expect it will take a number of months for me to arrive at conviction on that account.

When the first move to tighten policy is taken, I would expect it to begin a cycle of gradually rising rates. This will be a significant, even historic, transition that must be executed skillfully, with tools sufficient to the task, and with clear communication that fosters orderly market adjustment, to the extent possible. The discussion of so-called policy normalization documented in the latest minutes of the FOMC was just a first step, in my opinion.

It bears repeating that a discussion of policy normalization does not necessarily imply that a shift in policy is imminent. For the reasons I have discussed, I, as one policymaker, am not in a rush to get to liftoff. I continue to be comfortable with a projection of the second half of next year (2015) as likely timing.

[KELLY] EVANS: Next year Dallas Fed President Richard Fisher just said he thinks more of the Fed is coming around to his view which is a more hawkish one. I guess that means that you are not one of them?

LOCKHART: I still maintain that sometime around next year onward perhaps in the second half of next year is likely to be the right time for considering a rate move. I am still looking for let's say an accumulation of validating data to tell us that we are on the track that we need to be on to close in on our objectives. So I guess I am a little bit slower on the trigger than Richard Fisher.

“I’m holding to the mid-2015 view” when it comes to the timing of the Fed’s first increase in what are now near zero short-term interest rates, Mr. Lockhart said. “I’m a little bit more cautious then perhaps some others in declaring that the evidence we’ve seen in the last few months of a stronger economy necessarily tells us we’re going to stay on the necessary track to achieve our objectives,” he said.

Mr. Lockhart has held this view for some time, but he added that things could change for monetary policy if the economy surprises to the upside.

“If we see very, very strong data and it exceeds expectations, it could possibly move forward” the timing of that first increase in short-term rates, the official said. But the policymaker also said he would like to see “several more months of confirming evidence” before changing his outlook for monetary policy.

The appreciation of the dollar since last summer will likely affect the export sector, to some extent. My view is that the impact of the dollar's more expensive exchange value and, for that matter, the direct impact of lower oil prices on the energy sector are not severe for the national economy as a whole. But whenever two major world "prices" adjust so markedly, unanticipated second- and third-order effects could result. Geopolitical event risk connected to the rapid adjustment of these globally high-impact prices cannot be dismissed. Analytical humility is a sensible posture.

I think the momentum evident in the second half of 2014 will carry over into 2015, and the ongoing outlook will remain solid.

If that is indeed the case, I believe the first action to raise interest rates will in all likelihood be justified by the middle of the year.

The phrase "middle of the year" is admittedly not very precise. That's purposeful on my part. Understandably, some financial market participants are fixated on what exact month the first move will occur. Perhaps it's easy for me to say, but I don't think the exact timing of liftoff is the most important concern. A couple of years hence, whether the first rate increase came at a particular meeting or anotherwhether a bit earlier or later than expectedisn't going to make a great deal of difference for the real, Main Street economy.

The key liftoff decision criteria ought to be closely linked to the FOMC's two principal policy objectivesmaximum employment and low and stable inflation. In my view, the biggest factor influencing the actual timing of a liftoff decision should be the Committee's confidence that these objectives will be achieved in an acceptable timeframe and, especially, that inflation will move at deliberate speed toward the target of 2 percent per annum.
...
It's quite possible there will be considerable ambiguity in the picture presented by data in the first half of the year. Beyond the noise in inflation numbers, it's obvious there is simply a lot moving around at this timeoil prices, the dollar, even quarterly growth numbers, in all likelihood.

Noisy, jumpy data affect my confidence in the outlook. I'm likely to decide what policy decision to support based on where I think things are headed. When the numbers come in noisy, it's just harder.

If the early months of this year bring mixed news on the economy, the risk manager in me will lean to preferring a later date for the first policy move to an earlier one. That said, after six years of recovery and considering all that that has both transpired and been accomplished, I don't think we policymakers should get too rigid about liftoff a little earlier or later. My preferred timing may not be the Committee's consensus decision.
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At the recent meeting of the FOMC in December, the Committee made an adjustment of its forward guidance by introducing the theme of patience in beginning to normalize the stance of policy. I supported and expect to continue to support a patient approach, one that is relatively cautious and conservative as regards the pace of normalization of rates.

When it comes to lifting the Feds short-term interest rate target off the near-zero levels its occupied since the end of 2008, I continue to believe that all meetings from June onward should be on the table, the official said in an interview with The Wall Street Journal.
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Mr. Lockhart said in the interview the dearth of inflation in the economy remains a concern to him, even though the yawning gap between where inflation now stands and the Feds 2% price target is significantly driven by the drop in oil prices. He said he will likely have to make a mental trade off between decent growth, good hiring gains, and weak inflation, when he decides about rate rises.

But to support a rate increase, Id like to have evidence the inflation data is firming, or at a minimum, theres no deterioration in the inflation numbers, Mr. Lockhart said. He added, I cannot interpret what we have seen so far as very solid evidence inflation is firming. But he also said Im not interpreting what we are seeing in the numbers as a lower or strong disinflationary impulse.
...
He said when the Fed meets next month, its pledge to remain patient on the timing of rate increases will be on the table. Many of his Fed colleagues are ready to ditch the language to provide the Fed more flexibility to respond to the economy. But Mr. Lockhart is more circumspect.

I could go either way on this, he said, adding Im keeping an open mind when the Fed next debates this matter. Mr. Lockhart said it was possible the Fed could strike the patient pledge and add some sort of undefined bridging language about the outlook that would hold it over until rate hikes actually arrive. That said, Mr. Lockhart allowed that taking patient out would allow the Fed flexibility.

In the interview, Mr. Lockhart cautioned that any desire by Fed officials to raise rates is purely driven by the state of the economy. I dont think any central banker, and certainly anyone on the FOMC, has some kind of war weariness with interest rates at their current level, he said. Rates will rise when it is time to raise them, the official said.

WSJ: Some people have raised the idea maybe you signal it in September and then wait until October to act. Do you want to get into this pattern of signaling, waiting and then moving?

LOCKHART: I am one who very strongly would like to avoid unnecessary market volatility around the announcement of liftoff. But we have put a stake on the grounds that we are going to make a decision based on the data. It is data-dependent. That makes it much more difficult to signal because that suggests that the data, right up to the meeting, all is taken into consideration. That makes it difficult to make a decision a meeting in advance and then somehow signal it. You can make small gestures of signal. I would say that the inclusion of the word “some” in our statement is that kind of small indication of leaning in a particular direction without completely signaling certitude or eliminating any optionality.

WSJ: Tell me about that word “some.” Did you all spend a lot of time talking about that four-letter word?

LOCKHART: Some time. Since it was a change from the previous statement there had to be discussion of whether people wanted it in or didn’t want it in. There was some time devoted to discussing it. I interpreted it as meaning a bit more or a little bit more. That is a qualifier that conveys to the public that we’re getting closer.

I would say the inflation picture will be hard to read in the coming weeks, perhaps months. Therefore the conclusion that I will have to draw—and any individual participant on the [Federal Open Market Committee] will have to draw—in terms of being reasonably confident that inflation will converge in the medium term back to target, is going to be more of a composite of indirect evidence or indirect indicators than being satisfied with the direct evidence on inflation.

Having said that, one of the ways I go about evaluating inflation—I obviously like everyone else look at the 12-month number. Then I look at the near-term, shorter-horizon numbers. The three-month number gives me more of a sense of a run rate, the six month number has some of those benefits as well. Some of the shorter-horizon inflation numbers in the [personal consumption expenditures[ price index seem to be firming relative to the longer horizon. I take some courage from that.

...

My own approach to that is to say is I think we have to put significant weight on the accumulated progress we have seen quite literally over a number of years, but certainly since the first of the year, and not be overly influenced by the gyrations that so often occur in month-to-month data. That is not to say that you ignore the evidence that is most proximate to the date of having to make a decision, but I won’t be overly influenced by just the latest thing I’ve heard on the economy. I do think this is a time to try to take a pretty broad perspective, a pretty long horizon perspective to where the economy is relative to where it was and whether a policy rate at zero continues to be appropriate for the circumstances.

...

I want to sort of hold off on {the specific question of whether liftoff will come in September}. I have said publicly before that I lean toward September and I am still very open to a September move.

...

One framework that I will be using will be looking for any indication in the economic data that undermines my basic belief about the track of the economy... I will be looking closely at all evidence that we see in the data for indications that my basic assumptions are wrong or should be doubted... That is going to be one of the principal ways I will go about judging the question of whether liftoff in September is appropriate or not. To interpret that, that means I think there is a high bar right now to not acting, speaking for myself. It will take a significant deterioration in the economic picture for me to be disinclined to move ahead.

“I remain predisposed to September being a possible date for liftoff,” he said. “At the same time, in the greater scheme of things, I don’t think (waiting) a meeting or two is going to be decisive for the U.S. economy.”

The economy’s progress since the start of the year has been “quite encouraging,” Mr. Lockhart said in the speech. He said he has more confidence in the economy’s resilience compared with just a few months ago, and is “much less concerned” about a reversal of economic fortune.

Mr. Lockhart reiterated there is no preordained date for liftoff, and the timing will be data dependent. But normal gyrations in the monthly data won’t be a decisive factor in his decision-making.

”I am not expecting the data signals to point uniformly in the same direction,” he said. “I don’t need this. I’m prepared to see mixed data.”

The path of future interest rate increases is likely to be gradual, echoing remarks from other Fed officials, adding that pace is likely to be appropriate “for some time.”

Asked what he meant by gradual, he told reporters it means “something less frequent than every meeting.”

We are sort of anxious to get going, but given the events of the last several weeks, a risk factor has arisen...

It has to be considered an open question whether we move now or wait a little while.

I think the case for checking off the criterion of "reasonable confidence" that inflation will converge to the 2 percent target is harder to make than employment. Even so, I have gotten comfortable enough on the inflation question to take a first step in one of the coming FOMC meetings in what will likely be an extended process of normalization of the interest-rate environment.

As things settle down, I will be ready for the first policy move on the path to a more normal interest-rate environment. I am confident the much-used phrase "later this year" is still operative.

Lockhart said he voted with the Federal Open Market Committee majority last week to keep interest rates near zero because he didn’t want to tighten monetary policy in “the teeth of volatility.”

“But at the same time I feel very close to the right time,” to begin tightening, he said Tuesday after a speech in Montgomery, Alabama.

"China is slowing to still a very respectable pace of growth. It is ratcheting down a little bit, but there is a decent chance that the world is overreacting," [Lockhart] said.

"Markets should appreciate that the likelihood of substantial spillover to the U.S. domestic economy from developments abroad...is likely to be small.”

As I anticipate the signal value of incoming information over the next couple of weeks to the October meeting and the nine weeks to the December meeting, I think consumer data are likely to be the most telling. The consumer-based dimension of the economy has been robust for several months. By watching and analyzing the consumer numbers carefully, I hope to avoid the trap of letting one or two months' specific data overly influence my outlook for the economy overall.

I continue to feel that cumulative progress is consistent with liftoff relatively soon. In weighing the timing of a liftoff decision, I'm trying to keep the endgame in focus. For me, the endgame is to begin and sustain an orderly process of normalization when the time is right and when the balance of risks gives us confidence we will not be forced to reverse course. It's also vital, in my view, to keep attention mostly on the real side—the Main Street economy. Financial market gyrations should be influential in a decision only to the extent they could plausibly affect real activity through pretty clear and understood channels.

Mr. Lockhart said the idea the Fed might face economic conditions so worrisome that it would have to turn to fresh stimulus efforts are unlikely. He pointed out while he's watching the conversation about the possibility of using negative short-term rates to boost growth, "the notion we would have to use that tool in the near term is not very plausible."

“We are getting much closer to the finish line from the point of view of whatever you would consider full employment,” Lockhart told reporters Monday after a speech in Orlando, Florida. “I would expect to continue to make progress. So the beginning of normalization of interest rates I think is quite justifiable in the context of continuing progress of multiple measures of employment.”

“I can’t anticipate whether in the committee’s judgment there is enough data in October” for a move at that gathering of the FOMC, he said. “I think October is a live meeting. Clearly, there is the potential that the data coming in advance of the October meeting will be sufficient. And as I said in my remarks, and I repeated, we will have a lot more in December.”

Though my assessment of the Taylor framework elements leads me to the view that liftoff will soon be appropriate, I am not concerned that the FOMC is behind the curve. Liftoff remains a close call. A relatively small adjustment in an estimate of the neutral rate, or revisions in my forecast of how quickly remaining output and inflation-target gaps might close, could quite easily point to a longer period for a zero funds rate.

I am now reasonably satisfied the situation has settled down... So I am comfortable with moving off zero soon, conditioned on no marked deterioration in economic conditions.

Once the Federal Reserve lifts rates off near-zero levels, it will have to reconsider its communication on tracking inflation, Mr. Lockhart said. “I think it [the communication] will have to shift to a new phase of describing how we’re going to be monitoring inflation” once the Fed begins tightening, he said in a question-and-answer session with reporters here.

One way to "see through" transitory factors is to use so-called trimmed-mean inflation estimations. These price statistics eliminate the largest monthly price swings—those that often produce noise in the numbers. Trimmed-mean measures have been running much closer to the 2 percent target. The Federal Reserve Bank of Dallas's trimmed-mean index, for example, is up 1.7 percent over the past year. Comparing this and like calculations to headline numbers suggests to me that much of what's suppressing inflation is transitory in nature. I have bought into that view.

I would characterize quarterly GDP growth estimates as being of medium reliability. They are subject to frequent, and sometimes sizable, revisions. As another check on the GDP growth numbers I just cited, we can look at a second method that calculates gross domestic income, or GDI. In theory, GDI should equal GDP, but that's rarely the case in practice.

“Moving up gradually means not every meeting, in all likelihood,” Lockhart said in an interview Monday with WABE, the Atlanta public broadcasting radio station. “The rate of rising interest rates will be more like every other meeting.”

Last week we saw a global selloff in stock markets apparently triggered by data from China that fell short of expectations. The bearish environment was compounded by tensions between Iran and Saudi Arabia, the bomb test claimed by North Korea, and lower oil prices. When such volatility develops, I think it's helpful to look at the real economy of the United States (as opposed to the financial economy) and ask if something is fundamentally wrong. Are there serious imbalances that make the broad economy vulnerable to foreign shocks? I don't see that kind of connection in current circumstances.

I'm forecasting inflation readings to start to converge to our 2 percent target in 2016. I supported the FOMC's decision in December to lift off. The Committee had laid out a criterion of having "reasonable confidence" that the inflation rate would move to target in the medium term. From my perspective, our satisfaction of the criterion of "reasonable confidence" was based on projections of the most likely outcome.

“We remain concerned about the potential for the CRE market to overheat and hurt banks again,” Lockhart said, referring to commercial real estate. Bank regulatory agencies issued a statement in December that calls for ”sensible risk management practices regarding” real estate, he said.

Overall, I see the recent data as positive. I believe a forecast of sustained moderate growth momentum is realistic and remains the likely scenario. In my opinion, there is sufficient momentum evidenced by the economic data to justify a further step at one of the coming meetings, possibly as early as the meeting scheduled for end of April.

Much has been made of the implications of the 17 independent forecasts submitted by Committee participants, taken together. The number of interest-rate increases in 2016 implied by the median forecast drawn from participants' submissions was reduced from the December projection. In past communications, we emphasized that rates would likely rise gradually and, consequently, monetary policy would likely remain quite accommodative for some time. Now it appears the Committee has signaled an even more cautious and deliberate approach than that implied in December.

So what gives? Well, first, let me reemphasize a message frequently repeated in communications of the Committee. There is no pre-set path of policy decisions. There is no date-specific plan that the public could take as a committed course of action. Decisions to raise rates will be data-dependent. To my way of thinking, this means that at each decision point (each meeting), the Committee will reevaluate whether the real economy—the Main Street economy—remains on the assumed path to full employment and price stability. The Committee will consider information received since the last meeting and what that information implies for the outlook. And, importantly, the Committee will take account of the context of risks and uncertainties surrounding the outlook.

I would argue that the real economy—the Main Street economy—remains substantially on the path envisioned by Committee participants at the time of the liftoff decision in December. However, the context of risks and uncertainties has shifted somewhat. In my view, this explains the Committee's changed sentiment regarding the speed of normalization, the pace of rate increases.

In my opinion, the outlook for 2016 and into 2017 swings on the question of whether domestic demand will in fact hold up.

I see the economy on a growth track that should produce moderate growth this year—between 2 percent and 2 1/2 percent.

Based on what I have seen, I am not going to be advocating a move in April -- I have changed my view.

Hays: Let's talk about the Fed's reaction function broadly, but also specifically to Dennis Lockhart. You also said not too long ago you were forecasting you said two rate hikes this year, the possibility of three.

So let's start with what do you have to see, Dennis Lockhart, to be on board for the next rate hike?

Lockhart: I am -- let me put it this way -- I am framing my decisions related to let's say April, June, and thereafter on four principal criteria.

• The first is the growth numbers, and how growth seems to be trending. Most importantly, are we sustaining momentum in terms of growth?
  
  
• The second would be the employment numbers. And I would be using a kind of threshold of 200,000 payroll jobs a month as a good indicator of a continuing, strong job picture, employment picture.
  
  I would say at the same time that as we move forward, if we continue to make progress in the economy, you would expect naturally that that jobs number would decline. But for the moment, I'm saying 200,000 a month as a kind of threshold number.
  
  
• The third aspect would be inflation. And I'm paying particular attention right now to core inflation and trimmed mean cuts of inflation to try to understand the underlying strengths of upward price pressure. So that's the third.
  
  
• And the fourth would be inflation expectations. And the direction that inflation expectations apparently are going or the explanation for break evens that seem to be declining.

Some overshoot for a limited period of time I think considering what other benefits that might have for the economy could be an acceptable situation. If we get above 2.5 percent, I would begin to start to get a little bit nervous.

And let me make another point that is important because the Committee has reiterated its position that our attitude towards inflation is symmetric. That is to say we think the cost to the economy of a shortfall inflation are equal to the costs to the economy or similar to the cost to the economy of an overshoot.

So we're not viewing two percent as a ceiling. And I think that suggests that some tolerance of overshooting two percent would be acceptable.

One reason I am let's say supportive of a patient and cautious posture is because I don't think the (Fed) is behind the curve particularly as it relates to inflation.

The United States could see two further interest rate rises this year but uncertainties abound including the impact on the U.S. economy should Britain vote to leave the European Union, Atlanta Fed President Dennis Lockhart said on Tuesday.

"Two rate hikes are certainly possible. We have enough (Fed policy) meetings remaining but it depends entirely on how the economy evolves," Lockhart told reporters in Amelia Island, Florida.

While Lockhart said markets should put more probability on June being "a real option", he did little to signal that he felt the economy would be sufficiently settled for a June increase.

"Brexit could be a source of heightened global uncertainty," Lockhart said in a speech before the World Affairs Council of Jacksonville, Florida, adding it "has some potential to loom large as we approach the June meeting."

. . . 

"It is the repercussions [Brexit's] for the U.S. economy that would concern me...it's really a question of indications in financial markets of a reaction to rising uncertainty and the degree of volatility we are seeing again in financial markets"

I'm sticking to the view that the remaining three quarters of the year will be much better than the first quarter. Therefore, the first quarter is an anomaly. Either it's statistical noise or it's just similar to the way we've seen first quarters in recent years.