Jeffrey Lacker

It is true that markups are now elevated by historical standards, and thus are likely to trend down in the near term. But should the emerging step-down in productivity growth persist and markups not decline rapidly, real interest rates may need to rise more rapidly than is now anticipated.

Even if inflation remains low and constant, as we would like, we may still need to move the Fed funds rate fairly often.

Recent data suggest that a slowdown in productivity growth may already be in train.

Unless markups shrink to absorb the attendant acceleration in unit labor costs, the result would be upward pressure on inflation.

The key improvement in 2004 has been the long-awaited pickup in net job growth.

The importance of productivity growth for the economic outlook stems from its role as a link between aggregate demand and labor market conditions, and the consequent pressures on real interest rates. Slower productivity growth, for any given rate of demand growth, means more rapid employment growth and less downward pressure on wages, and could therefore necessitate a steeper-than-otherwise path for real interest rates.

The sluggish pace of job gains prior to this year has been a reflection of the truly astonishing extent to which firms have been able to expand real output without needing to add workers. This phenomenon appears to be drawing to a close.

Inflation has remained steady this past year [2004], and, just as importantly, inflation expectations have been contained.

Looking forward to 2005, it seems reasonable to project a continuation of growth along a quite similar trajectory.

Consumer spending, fueled by expectations of sustained income growth, should continue to expand at something near the strong pace we have been seeing.

Business investment spending might well show a temporary slowdown in the first quarter after the expiration of the tax incentives, but should resume expanding at a robust pace shortly thereafter, reflecting assessments that substantial opportunities remain to enhance efficiency by installing new capital goods, particularly IT and communications equipment.

Output growth next year should also be helped by a reduction in the drag from net exports. Although exports will be dampened somewhat by moderating growth among our major trading partners, the recent fall in the dollar ought to support export growth and contain imports as well. On the other hand, the declining fiscal policy impetus and the likely downward trend in housing starts will both detract from output growth.

GDP growth seems most likely to lie in the three and one half to four percent range next year, barring a large unforeseen economic shock.

The outlook for productivity is pivotal to next year’s economic prospects, and it is especially hard to project at the present time.

For 2005, I expect inflation to come in between one and two percent, as measured by the PCE price index, and I expect inflation expectations to remain contained.

My discussion of the outlook for 2005 has placed productivity trends rather than inflation at center stage, because it strikes me that greater uncertainty surrounds productivity over the coming year.

As a general principle — that is to say, looking beyond the current tightening cycle — real interest rates must fluctuate as economic fundamentals change, even in the absence of visible perturbations in inflation prospects.

Monetary policy is capable of preventing oil price increases, or changes in the foreign exchange value of the dollar for that matter, from showing through to the underlying inflation rate.

We are well-positioned for fairly healthy economic conditions next year. Real growth, led by healthy capital formation and solid consumer outlays, should boost employment more rapidly than the working age population grows, and inflation should remain well-contained. A central banker couldn’t ask for much more than that.

There is a pace at which market participants expect us to raise...It could turn out to be more rapid than that, or less rapid than that.

I saw the employment index was down. That caught my attention. But we're going to have to wait and see if it is a big deal.

We're going to have to raise and lower interest rates more frequently than you might otherwise think because, even if inflation doesn't wiggle around, we're just going to have to be vigilant...That's a statement apart from the current (tightening) cycle.

We can't wait until we see the whites of the eyes of inflation picking up.

There is a fundamental congruence between the effects of trade and technology on labor market outcomes. Both can displace workers and force them to make the transition to other sectors. But both ultimately elevate standards of living. Few seriously propose impeding technological progress for the sake of jobs. We should be equally hesitant to impede trade.

PPI didn't alter my inflation outlook perceptibly.

Understanding the causes and consequences of economic change are vital to creating a broadly accepted belief in the benefits of technological innovation, unrestricted trade, and the other drivers of economic progress.

I have argued that trade-related job losses are fundamentally no different from job losses arising out of the ongoing turbulence of technological change. It’s hard to see why one set of transitioning workers should be singled out for favorable treatment, except perhaps to reduce political opposition to trade liberalization.

Adaptability will be increasingly important in the years ahead.  A worker can no longer count on an initial occupation to maintain its relative position over time.

Whether trade or technology is the major force, the message is the same. The world has become a much more challenging place for workers with lower skills and workers whose skills are largely specific to their job or industry. The weight of empirical evidence strongly suggests that erecting barriers to trade would ultimately prove a counterproductive response to this phenomenon.

We have what has been called a “jobless recovery” — net employment growth has been relatively subdued coming out of this business cycle trough. Arithmetically this can only happen with an increase in productivity, so in this sense the jobless recovery reflects strong productivity growth.

I don't see any reason why one would expect more excessive risk-taking with lower real interest rates. I don't see any sign of excessive risk-taking.

In dollar terms, capital spending is on a solidly upward trend and, adjusted for price changes, spending has been even stronger given the continuing decline on a secular basis in equipment prices.

Real short-term interest rates can't stay where they are now.

It (weak dollar) doesn't need to pass through to the overall underlying inflation rate and as a result I'm confident that our economy and our policy apparatus is resilient enough to respond to the evolution of the foreign exchange value of the dollar.

I think it's reasonable to forecast a steady decline in residential investment, no collapse, but a steady decline.

One percent appears to be a good target for actual inflation...An inflation rate a bit above zero gives us a bit more leeway to lower real interest rates to prevent inflation from falling below target. 

My sympathy for the first quarter 'pothole" hypothesis has eroded.

Ambiguity about the Fed’s long-run inflation intentions has outlived its usefulness.

We've definitely had a couple of higher-than-anticipated inflation numbers...I'm still relatively sanguine...It's just been a month's worth of numbers that look a little firmer than we expected.  I think we're still on track.

If inflation moved outside the range we would feel compelled, I believe, to acknowledge that fact and to state how inflation will be brought back within the range. A range rather than a point target would give the Fed a reasonable “safe harbor” within which we would not be pressed to explain fluctuations in inflation. The narrowness of a 1-percentage-point range, however, would discipline us to explain any substantial deviations of inflation from the target.

There are no circumstances, I would submit, in which expected inflation should be outside of a narrow band around the target for very long.

I believe that the adoption and announcement of an explicit, numerical, long-run inflation target by the Fed would enhance the effectiveness of monetary policy.

A well-timed preemptive increase in the federal funds rate is nothing to be feared. In 1994, it was necessary to take the real federal funds rate...from around zero up to around 3 percent in order to avert the potential build-up of inflationary pressures. And yet real growth picked up and the unemployment rate trended down.

To keep inflation well-anchored, the Fed must be prepared to move the federal funds rate around over the business cycle even though inflation remains stable.

Critics argue that while [the Fed] want[s] the public to believe inflation will remain well-anchored in the future, when the future finally rolls around, [it] might want the flexibility to pursue policies that are inconsistent with the earlier promise implied by an inflation target. In other words, [it] might find the commitment implied by [its] announced inflation target constraining. I would argue that this is a flexibility the Fed should be happy to do without.

There is widespread agreement among central bankers and monetary economists that although, over the long run, it is feasible for the central bank to control inflation, long-run growth and employment are predominantly determined by forces independent of monetary policy. So it makes little sense for the central bank to adopt a long-run objective for growth or employment.

The [latest FOMC minutes] cite three benefits of an explicit price-stability objective: (1) its usefulness as an anchor for long-term inflation expectations, (2) its power to enhance the clarity of Committee deliberations, and (3) its usefulness as a communication tool...I strongly support each of the three reasons given in the minutes in favor of an explicit long-run numerical objective for inflation.

I think both experience and economic theory strongly suggest that the best contribution monetary policy can make to promoting employment and growth is by tying down inflation and inflation expectations. That is, in the long run, employment and growth are maximized by keeping inflation low and stable.

I believe that the Fed’s experience in May and June 2003 indicates that references to inflationary or deflationary risks in the policy statements we now release after every meeting cannot reliably substitute for an explicit inflation target. The statement issued following the May 2003 FOMC meeting asserted that a fall in inflation — then about 1 percent — would be “unwelcome.” This came as a something of a surprise to markets and caused a sharp reaction in long-term rates. If an inflation target range had been in place in 2003 with a lower bound of 1 percent, the public could have inferred the Fed’s growing concern.

The effectiveness of financial market participation as an aid to household risk management can only be fairly assessed on an ex ante basis — that is, from the perspective of before the financial transaction has been initiated...

Popular discussions of lending practices often take a decidedly ex post perspective, revolving around the consequences of particularly bad outcomes. This amounts to policy by anecdote. An ex ante approach would ask instead whether a particular practice expands the menu of borrowing options in a way that is useful to households in pursuing their economic goals.

The goal of community development lending is to facilitate the ability of low and moderate income households to make use of financial markets and instruments for their own benefit. In other words, policy is about the well-being of people, not neighborhoods. Research that focuses on neighborhood-wide outcomes — even important outcomes like home ownership or property values — in some sense misses the mark.

We ought to be building datasets containing detailed and comprehensive records of financial transactions as well as income and spending for a panel of households over the course of many years. So if I were to try to identify the main challenges in community development research, one would be to find ways of improving our understanding of how changes in financial institutions, instruments and regulation have affected the behavior and welfare of individual households in the population of interest. This is not an easy task. One obvious reason for the greater focus on lenders and neighborhoods is data availability. But to the extent to which our research program is driven by policy questions, I would hope that our future research efforts are guided more by a focus on people.

The future of community affairs research is promising in my view, despite the pitfalls...The fact that popular policy discussions in this area are so prone to error also points out the social value of good solid research. 

The potential for moral hazard due to a public sector safety net, and in particular the provision of central bank credit in connection with payment operations, is to my mind the central rationale for central bank oversight of payment system participants...It is my sense that central banks have not come close to fully offsetting the safety net’s moral hazard distortion, although I would be hard pressed to document that claim, except to note the extent to which access to central bank settlement seems to be highly prized by financial institutions. 

Underpriced access to central bank credit will of course distort private sector choices. Absent countermeasures, banks will take excessive risks and central bank credit will be overused, a distortion often referred to as moral hazard.

Years ago, when many aspects of current arrangements were put in place, operational considerations made it costly to implement systems that did not automatically extend daylight central bank credit in one form or another. New technologies may have significantly altered this cost-benefit trade-off, and in my opinion a re-examination of daylight credit policies is in order.

A focus on central bank credit also makes clear that paying interest on reserves is more important than is commonly appreciated. The prohibition of interest on central bank deposits, as in the U.S., greatly enhances the demand for daylight credit, in the sense that larger overnight balances act as substitutes for daylight overdrafts. As a result, limitations on central bank credit extension would be less costly if reserves earned interest.

The relation of central bank credit to the broader public safety net has implications that are sometimes overlooked. For example, the collateralization of central bank credit extension may reduce risks to the central bank, but it can increase risk to the deposit insurance fund. Therefore, the central bank ought to consider more than just its own balance sheet risk in making lending decisions. This is especially important because, as the lender of last resort, the central bank can often force an institution’s closure by refusing credit.

My sense, however, is that there are far less by way of economies of scope than would be needed to justify, on economic efficiency grounds, the current scale of Federal Reserve service provision, particularly in clearing “retail” payments such as checks and ACH. In fact, I have argued elsewhere that the evidence suggests that the Fed’s role in clearing retail payments rests on altering the allocation of clearing costs that would result from purely private provision.

I think the uncertainties going forward are the extent to which the growth in investment spending stays about where it was in the first quarter or picks up to where it was last year... And then oil prices are obviously a source of uncertainty. I think we can handle fluctuations around the range we've seen, but a major breakout would be another kettle of fish.

I've been really pleased that the market based measures of inflation expectations have subsided in the last month or two. It is clear now that the whiff of softness [in growth] that we got in the spring was transitory and the inflation numbers have been better after an adverse bulge.

I think we're fairly accommodative at these rates. I agree the outlook ... as the FOMC (Federal Open Market Committee) statement reads, is for continued measured increases. I think that it is too early to say when we're going to stop. It's obviously going to be data-dependent.

Long-term interest rates are most likely low by historical standards because expectations of future inflation are very well maintained right now.

We need to keep in mind that most measures designed to protect consumers from bad credit market outcomes also raise lending costs and can prevent them from obtaining credit in the first place...Having said that, policymakers should be alert for opportunities to reduce adverse outcomes without harming credit availability – in other words, to improve the terms of the trade-off between credit availability and borrower protection.

While some policies that carefully target truly abusive practices are warranted, the broader risk is of a regulatory overreaction that stifles much of the benefit of the technology-driven expansion in consumer credit.

It seems quite reasonable to foresee at some point house price appreciation leveling off and investment in housing tapering off to some extent.

The inflation outlook is more favorable than it was a couple of months ago. I've been happy that the pass-through to core (prices) has been less than feared and the expectations embedded (in inflation-linked bonds) has subsided.

I think for the emerging Asian economies, for them the big lesson I would take away is that buffer stocks of external reserves seem pretty useful and that might be what's driving these savings flows.

Broad efforts to improve financial literacy may not add to a lender's near-term bottom line, but financial institutions, both individually and as a whole, depend critically on their customers' trust. And trust is built on understanding.

The value of financial literacy has become apparent...An electorate that has a broad appreciation of the efficiency of credit markets will also have an easier time sorting out when any particular policy proposal is truly in their interests.  In the long run, this is the path to better banking policy. After all, we in the United States have arguably one of the most efficient retail credit markets in the world. Let's not kill the goose that lays golden eggs.

A moderate pace of continued tightening is a sensible outlook at this point and it's too soon to say when we're going to stop.

Dramatic improvements in credit availability are accompanied by predictable increases in the incidence of delinquencies and abuse, as new products proliferate and new borrowers are drawn into the market. The spread of adverse outcomes inevitably triggers calls for new regulatory constraints on lenders. But while truly abusive practices certainly deserve regulatory attention, policy measures that impede the functioning of credit markets need to be approached cautiously to avoid an overreaction that stymies much of the benefit of the innovations in retail credit practices.

I wouldn't want a pause in tightening, if it ultimately occurs, to reduce the sensitivity of expected interest rate policy to incoming data.

Asked specifically his opinion of the baseball analogy used by Dallas Fed Bank President Richard Fisher, Lacker refused to comment, saying that in his case he has not been able to think of an auto racing analogy.

Our international asset position can't drift indefinitely. Having said that, it has a lot of room to drift. I think Gov. Bernanke's argument for elevated global savings flows are keeping down real interest rates and are driving American consumption.

[Oil prices] always pose a bit of a concern to the extent that sharp increases pass through to core inflation, but what we've seen over the past several years is pass-through that's fairly limited.

In recent months we've had some core PCE numbers that are higher than I would like to see sustained. But I like where we are on a year-over-year basis and I think the general anticipation (is) for those monthly numbers to settle back down in the second half of the year.

I'm not willing to set a time frame on it but yes, I am comfortable with the measured pace characterization right now.

We seem to be on a fairly solid growth path and inflation expectations seem well-contained, and in that kind of situation, following through is probably the order of the day.

I think it is still too early to be foreseeing a pause.

Housing prices, like other asset prices, are a relative price, and I don't see those as a direct driver of inflationary trends.

[In the post-Greenspan era] Policy will less often be reacting to fluctuations in actual or expected inflation, and will more often be realigning real interest rates in response to changing economic fundamentals.

Thus far, market participants appear to believe that core inflation will remain contained. Survey measures of expected inflation rose sharply in September when retail gasoline prices reached their peak, but have come back down since. Measures of expected inflation derived from market prices of inflation-protected U.S. Treasury securities drifted up a bit this fall, but they too have returned to mid-summer levels. To maintain credibility for price stability, it is essential that monetary policy should respond vigorously to any visible erosion in inflation expectations.

Core inflation has been low and relatively steady in the last several years. The inflation measure that is widely preferred on methodological grounds, the price index for core personal consumption expenditures, has averaged 1.8 percent over the 12 months ending in October. That is within the 1-to-2 percent range that I and others have proposed as an announced target.  Although core PCE inflation on a year-over-year basis did drift above 2 percent for several months in late 2004 and early 2005 — it went as high as 2.3 percent at one point — it was only after the most recent Annual Revision to the National Income and Product Accounts that the series came in over 2 percent.

Immediately following Hurricane Katrina, as the magnitude of the effects on Gulf Coast energy production became clear, many observers came to fear that the resulting sharp increase in energy prices might lead to a broader increase in inflation, and perhaps even recessionary forces. These observers appeared to be reasoning by analogy to the 1970s, but I believe that analogy is mistaken. Inflation expectations were unanchored in the 1970s, the credibility of the Federal Reserve was low, and people expected the Fed to allow energy price shocks to feed through to overall inflation. The Fed often accommodated that expectation by preventing short-term real interest rates from rising. In fact, at times we kept nominal rates from rising as fast as inflation and thus provided further monetary stimulus. The Fed was then forced to raise rates dramatically to bring inflation back down, and in the process induced an economic contraction, exacerbating the real effects of the oil price shocks. Thus, the proper lesson from the 1970s is not that energy price shocks induce major recessions or cause widespread inflation; it is that monetary policy that reacts to energy price shocks by accommodating the rise in inflation can induce major recessions. Monetary policy should respond to energy shocks by remaining focused on price stability. That way, the economy can respond to energy price shocks the way it should — the relative price of energy increases, but core inflation remains anchored.

Differences between how economic fundamentals are expected to unfold and how they actually unfold can have important implications for real interest rates and thus for monetary policy. As I have emphasized elsewhere, a real interest rate is a relative price — the price of current resources relative to the future resources one either forgoes by borrowing or obtains by investing. Real interest rates need to respond to changes in the relative pressure on current versus future resources. Unpredicted movements in economic fundamentals, to the extent that they affect the relative pressure on current and future resources, thus will have implications for policy rates, even in situations in which inflation and inflation expectations are low and well-contained.

Apart from auto sales, which slid following expiration of the summer’s “employee discount” promotions, retail sales have held up well and overall consumer spending has continued to advance. And on the whole, holiday spending appears to be coming in stronger than many feared a month or two ago. I would argue that this episode illustrates quite well how consumption expenditures are governed predominantly by households’ assessment of their own future income prospects, rather than by any general economic nervousness, despite how they respond to telephone pollsters. With healthy income growth ahead and a reasonably strong overall job market, the outlook for consumer spending looks good.

Growth is on a solid footing, despite this year’s run-up in energy prices and the disruptions of a devastating hurricane season. After a brief pause this fall, employment has resumed expanding at a healthy pace, consumer spending continues to grow briskly, and business investment spending is robust. Granted, housing activity seems to be softening, and at least some potential price level pressures remain...But inflation expectations remain contained, and we at the Fed are well-positioned to resist inflation pressures, should they emerge. So all in all, it is quite a good outlook.

The multiple first-day bids and final sales at above asking prices that were observed in some markets seem to have become less common. And in some markets the amount of time a home stays on the market has returned to more typical levels. At the same time, the aggregate measures of housing activity have so far shown only limited pull-back from their peaks and remain at historically high levels. Still, mortgage rates are likely to stay somewhat above their recent lows in the coming year, so I would expect housing price appreciation to flatten out next year and aggregate residential investment to stop growing or perhaps even decline.

In the immediate aftermath of Hurricane Katrina, fears were widespread that consumers might pull back sharply on spending, both in response to sharply higher retail gasoline prices and out of a general sense of heightened anxiety about potential fallout from the storm damage. Survey measures of consumer confidence, which plummeted in September, seemed to bolster this view. But the effect of the storms on consumer outlays have turned out to be far more limited than expected, exemplifying the oft-cited resilience of the U.S. economy.

The fundamentals for business investment in equipment and software look quite sound. Business output is expanding steadily and real funding costs are relatively low, both because inflation-adjusted, risk-free rates have been low and because corporate risk spreads are relatively narrow. Evidently, there has been a sufficient flow of opportunities to deploy new capital profitably. Business investment in equipment and software has grown at over 11 percent in real terms since the first quarter of 2003, and it appears poised to grow at rates almost that strong next year.

[T]he price index for core personal consumption expenditures, has averaged 1.8 percent over the 12 months ending in November. That is within the 1-to-2 percent range that I and others have proposed as an announced target.

The overall outlook therefore is for a healthy expansion next year. Real GDP should grow at about 3.5 percent.

Thus, concerns that a flat yield curve could spell economic doom are "somewhat overblown."

"What we have in the yield curve inversion...is correlation without causality," Lacker explained.

"Some of the discussion reminds me of medieval times when the arrival of a comet would spark a sort of apocalyptic hysteria," he said.

From a Dow Jones Newswire report on comments to reporters after his speech.

On the demand side, there is some uncertainty regarding the rate at which housing activity is at all likely to cool in the coming year. Although I do not think that a sharp fall in housing investment is likely, a range of forecasts from flat to moderately declining seem reasonable.

One implication of this perspective on recent productivity trends is that the current expansion in business investment is laying a foundation for future growth in total factor productivity, and thus provides at least some grounds for optimism that productivity growth might come in at 2.5 percent or higher, rather than the long-run trend rate of 2.25 percent.

While continued growth in the share of output devoted to business investment seems highly probable, it is difficult to foresee with any certainty the scale of investment that businesses will find profitable to undertake, so spending growth in this category could well deviate from expectations.

Inflation is low and stable, and the public appears to be fairly confident that inflation will remain persistently low and stable.

But if the federal funds rate path becomes less predictable than it has been over the last 14 FOMC meetings, does that mean that the Committee must retreat to saying little beyond announcing its rate decisions when they are made? In my opinion, no. My sense is that there will still be room for forward-looking communications that entail more conditional statements about how policy is likely to react to evolving economic fundamentals, in contrast to the less conditional statements common since 2003.

Providing quantitative guidance to the public about the Committee’s long-run inflation intentions would have the benefit of reducing uncertainty about future monetary policy, and more securely anchoring long-run inflation expectations.

The 20th century saw a gradual but steady departure from the gold standard, culminating in the closing of the U.S. “gold window” in 1971. It is not surprising that expectational stability would have been lost around the same time. When inflation was observed to rise in the 1970s, the public saw no obvious mechanism in place for bringing it back down, and so higher inflation became built into people’s long-run expectations.

What should we look for in models of payment activity? One important principle is embodied in William Baxter’s (1983) Dictum—that the issuance, use, clearing and settlement of a payment instrument is a service of joint benefit to the buyer and the seller and that service is provided jointly by all parties to clearing and settlement. As a result, a sound economic evaluation of alternative payment policies requires assessing the effect of those alternatives on the well-being of and costs incurred by all of the parties involved. Models that omit the parties for whom banks are clearing and settling payments — the “end-users” — will fail to satisfy Baxter’s Dictum, and will be potentially misleading.

I would like to explore an alternative central bank policy regime that involves no daylight credit at all. Under this regime, the Fed would automatically “sweep” the overnight excess reserve balances of banks into reverse repurchase agreements. Specifically, at the close of Fedwire ( 6:30 p.m.) we would sell them U.S. Treasury securities in exchange for all of their excess reserve balance. At the opening of Fedwire on “the following day” (actually 9:00 p.m. the same night) the transaction would be reversed; we would buy back the securities and credit their account for the purchase amount, plus interest. Upon initiation of the service, the Fed would conduct a large one-time open market purchase of securities during the day to start the program up with abundant daylight reserves. If the interest rate were set close to or at the target fed funds rate, this scheme would allow us to curtail daylight credit without imposing much cost on banks. For every dollar of daylight credit we withdraw, we could supply an additional dollar of daylight reserves via the initial open market purchase.

Both survey data and the market prices of inflation-protected Treasury securities tell us that the public expects inflation to continue to be contained. I am confident that we at the Fed have the knowledge and the will to validate those expectations.

Over the last two months, for example, the core index has increased at a 1.8 percent annual rate as well. To put that number in perspective, it lies close to the 1 ½ percent figure that I and several others have proposed as an announced numerical objective for inflation.

Much of the popular response to consumer credit expansion and its byproducts has been less about prudential supervision, however, and more about consumer protection. Many proposals amount to calls for lending restrictions or the outright prohibition of some lending practices. This strikes me as a dangerous approach. In the long run, it would tend to slow innovation and constrain the availability of financial products to a broad range of consumers in order to protect the relatively few who use a credit product inappropriately or unadvisedly.

The expansion of retail credit has brought an increase in what one might call “bad outcomes” — households that face high debt burdens, have trouble meeting payment commitments, and perhaps even default and resort to bankruptcy.

I think there's a danger of inflation becoming entrenched at the level it is now with core inflation well over two and I think that most people and I myself personally would like to see it down around one-and-a-half percent..

Right now it's difficult at all times to get a hand on where people in the economy generally expect inflation to be. But right now I think there's, you know, a sense that inflation expectations are contained but having said that, there's a dispersion. There's, you know, a range of view about how rapidly inflation will come back down.
    The longer we let inflation remain, core inflation, remain where it is I think the more likely it is that expectations collapse on core inflation remaining about where it is now rather than declining as I would like to see it decline.
     So that's what I mean by becoming entrenched, becoming firmly lodged in the public's mind as an expectation that that's the inflation rate we're going to tolerate and I think that would be a mistake.

I just don't think that growth by itself is going to take inflation down. I'm not sure how many people really view that as going to be the key driving force of inflation going forward. What I think is more likely is the fact that the increases in core inflation we've seen thus far have been in response to oil price increases. And if oil prices - energy prices trace out the trajectory implied by futures markets, which is to say fairly flat from here on out, then that pressure from oil price increases is - on core inflation is likely to subside. And I think that's where, you know, where the hope is for bringing inflation down without further rate increases and we said that again, obviously in the camp of thinking that we needed to raise rates to make sure that inflation comes down.

The big question for the economy though is what sort of spillover effects we're going to get. There's this hypothesis floating around, this conjecture, about whether the slowdown in housing price appreciation will cut into consumer net worth and lead them to do sort of a reverse wealth effect reduce spending growth. And we haven't, I don't think, really seen that thus far.

     One convenient way {to calculate a neutral real funds rate} that's very popular and easy to use is to take the Federal Funds rate target and subtract trailing 12-months core CPE inflation and using that - use that essentially as a proxy for expected inflation going forward. If you have on hand expected measures of sort of inflation over a one year horizon you can use those as well...

    Well, we've been growing rapidly, taking slack out of the economy, and we're now making a transition to a period of sustained growth around trend. The last period of sustained growth around trend that we experienced was '95 to 2000. During that period measured the way I suggested, real rates were between three-and-a-quarter and five percent. Measured that way the real rate's current about just over two-and-three-quarters. So we're under three and some distance away from the bottom end of {the earlier range}.

In the next meeting, I'll obviously make an independent assessment, but I haven't seen anything since the last meeting that changes my assessment. 

In response to a question about whether he would dissent for a second consecutive meeting.

In response to the question:  "Are you worried that the Fed could lose its inflation-fighting credibility?"

I'm very concerned.  And it's not a big black or white thing, losing our credibility.  I think that everyone believes we wouldn't let the '70s happen again.  But an erosion from 1.5%, to let inflation, core inflation, drift from 1.5% up to 3%, I'm not sure people are convinced we wouldn't let that happen, and I think we ought to take action to prevent that notion from becoming lodged in peoples' minds.

The longer we go without signs of a deceleration in core inflation, the more we risk inflation becoming entrenched at this higher level. And if that happens, if people come to expect it to continue at two and three quarters, then it would take substantially more action on our part to bring it down to where we want to see it over time.

So that's the risk that I see, of inflation becoming entrenched at or above where it is now, and we're already seeing signs that that might be happening, because of the acceleration of compensation costs ...

A lot of our contacts within the district since the beginning of the year, since the spring, have been reporting that they're increasingly able to pass along cost increases, energy cost increases in the form of high prices — something we weren't seeing a year ago.

Chairman Bernanke has encouraged open discussion, encouraged us to question and challenge each other's positions and encouraged open dialogue within the meeting. I think he's also encouraged us to express fully our views on policy before he proposes a given policy proposal. He has moved in the direction of greater unscripted exchange of views, and that's been good.

I am not comfortable that we have got a downward trend that I can be that confident in at the present. And I am worried about the danger of inflation staying, remaining, about where it's been.

The question is how are we going to bring about restoring price stability.  My colleagues' views differed from mine. I thought that we needed another policy move to ensure that we had a high enough probability of getting back (to lower inflation levels).

Growth doesn't slow inflation, central banks slow inflation. It has to do with what really drives inflation dynamics.

Now that labor market conditions are fairly firm, the economy is transitioning to growth at a trend rate of around 3 percent per year — a pace at which job growth will match the growth in the number of workers over time.

I believe we are seeing a return to a more conventional level of housing market activity in which volume, inventories and time-on-market are closer to historical averages. This adjustment naturally involves a fair amount of uncertainty for market participants. Both buyers and sellers are probably more unsure than usual right now about where prices need to settle in order to clear markets. In the meantime, they are collectively engaged in a time-consuming process of discovering the prices at which expectations and plans of buyers and sellers are mutually consistent.

My sense is that the underwriting and pricing of mortgages has on the whole been sound, despite some individual anecdotes that suggest otherwise. The broad range of households that have taken out nontraditional mortgages are going to find them advantageous, even if, as with many financial products, a small fraction end up regretting their choice after the fact. Moreover, the banking industry looks healthy right now, with strong profitability and high levels of capital. Loan delinquencies are quite low by historical standards, as are chargeoffs of real estate loans. So it looks to me as if the end of the housing boom is unlikely to have any broader spillovers as a result of financial repercussions.

The fundamental underpinnings of near term investment demand are encouraging. Profitability is high, capacity utilization has been steadily rising, and many firms see strong demand for their products. Thus, it is not surprising that new orders for capital equipment increased 7.5 percent over the last year, and I see a solid outlook for capital spending over the next several quarters.

[O]ver the last six months job creation has averaged 118,000 jobs per month. While that sounds low, it’s actually pretty close to what we would need to keep employment growth in line with population growth.

Should inflation persist around the current elevated level, firmer monetary policy would be required to restore price stability. As a result, I believe policymakers will need to remain quite vigilant in the period ahead, to ensure that inflation moderates at a sufficient pace.

"I don't want to speak for any of my colleagues, but I'm unhappy with inflation where it is now," he said.

The recent core PCE trend "doesn't give me any confidence in how fast it's going to come down," Lacker said.

As reported by Dow Jones Newswires

Lacker said payroll growth around 100,000 going forward would be sufficient to keep labor market conditions "pretty firm."

"They'd have to ease by a lot more than that to throw a monkey wrench into consumer spending and that doesn't seem likely to me," he added.

As reported by Dow Jones

'[Q3 GDP] was a little stronger than I expected. Housing was a big drag. Business-side spending was pretty good. We are still not seeing spillover from housing.''

"I am expecting growth to return to potential sometime next year.''

"I am not hopeful a lot of slack is going to open up before we return to trend."

As reported by Dow Jones

[Lacker] said the reason inflation “seems to be so persistent ... is that we have not communicated very strongly that we want inflation to be lower and would be willing to take action to bring that about”.

He added the Fed sometimes talked about pass-through “as if it is a force of nature rather than a product of policy expectations”.

His remarks are likely to be seen by some Fed watchers as critical of Ben Bernanke, the Fed chairman, even though Mr Lacker was careful not to mention him by name.

Mr Lacker said he had been “surprised over the last several months by the extent to which the markets seem to discount the possibility of us firming policy further to bring inflation down”.

The safety net reduces the incentives of private financial counterparties to manage the exposures they take on. And these incentive effects arise not just from such explicit safety net guarantees as deposit insurance. They may also result from the expectations of private market participants about actions that the central bank or other public sector entity might take during a financial crisis. The mere possibility of public sector action to stem so-called "systemic" losses, such as central bank lending, can provide an implicit safety net that makes some participants more willing to hold concentrated exposures. Hence, under this moral hazard view of the need for regulation, the safety net itself can be a source of "systemic" risk.

The period since the early 1980s was also one of markedly diminished macroeconomic volatility. This change, which has been dubbed the "great moderation," shows up in virtually all aggregate time series for real variables. For example, expansions have been longer and recessions have been shallower and less frequent. This phenomenon has been noted by many authors and the relevant facts were described by Chairman Bernanke in a 2004 speech.

...a variety of other causes have been offered to explain the macroeconomic moderation, including better monetary policy and the good fortune of receiving smaller shocks. Nonetheless, a causal link between the great moderation and the simultaneous wave of financial innovation would seem to be a plausible conjecture.

Finally, when innovation occurs outside of the banking industry, regulators' main concern should be with the interactions between the regulated and unregulated sectors. For example, supervisors and institutions have focused heavily in recent years on strengthening counterparty risk management practices and the settlement infrastructures undergirding important new financial markets. As I noted earlier, supervising this boundary requires that regulators broadly understand the activities of the unregulated sector, but perhaps even more important, it also requires regulators to understand how innovations change the ways in which exposures can flow back into the banking sector.

[T]he trend rate of GDP growth — by which I mean the rate consistent with trend growth in productivity and the labor force — is more like 3 percent.

[I]n the second quarter of this year real GDP only grew at a 2.6 percent rate. In the third quarter, growth dropped to a 2.2 percent rate, and growth is likely to be about the same, or perhaps a bit higher in the current quarter.

The distinguishing feature of the current transition is the magnitude of the adjustment in the housing market, which comes at the end of what has been an amazing, decade-long run. The homeownership rate increased by 4 full percentage points from 1995 to 2005, and the number of houses built per year increased by 46 percent over that 10-year period.

Some observers have called this extraordinary behavior of the housing market in recent years a bubble. I don't find that term useful or particularly accurate, since the behavior of housing appears to have been based on solid fundamentals.

The longer core inflation persists above 2 percent, the greater the danger of inflation becoming entrenched at too high a rate.

Many forecasters have been saying core inflation will moderate in the near term, and this certainly would be desirable. But such a moderation is not yet evident, despite the two most recent CPI reports. For example, the three-month average rate of change in the core PCE price index has been oscillating between 1.8 percent and 2.9 percent since last year's hurricanes, and stands at 2.7 percent as of October. In view of this recent record, it would take several months worth of data to provide statistically convincing evidence of a moderation in inflation. In the meantime, the risk that core inflation surges again, or does not subside as desired, clearly remains the predominant macroeconomic policy risk.

The outlook for real growth in 2007, then, is for continued strength in consumer spending and business investment to be partially offset, particularly early next year, by the drag from the housing market.  Growth will start the year on the low side, but should be back to about 3 percent by the end of next year.  So my best guess right now is that real GDP growth will average between 2 ½ and 2 ¾ percent in 2007. 

Growth will start the year on the low side, but should be back to about 3 percent by the end of the year. So my best guess right now is that real GDP growth will average between 2 ½ and 2 ¾ percent in 2007.  A month or two ago, this forecast would have been somewhat higher than the consensus of widely quoted analysts. But the data since then have been stronger than most observers expected, particularly the very robust data on consumer spending and employment. As a result, many analysts have marked up their forecasts, and so the projections I’ve presented today are now fairly mainstream.

But since we’re not in Lake Wobegon, we can’t be above average all the time. Indeed, in the second quarter of last year, real GDP only grew at a 2.6 percent rate. In the third quarter, growth dropped to a 2.0 percent rate, and growth is likely to remain below average in the current quarter. Since growth clearly has slowed, the question on many people’s minds is, “What’s next?”

For some guidance, we can look back to similar episodes in the past. The long expansions of the 1980s and the 1990s resemble our current expansion in several key respects. Both were unusually long, by historical standards. Both saw substantial increases in production, employment and wealth. And in both cycles, there was a somewhat bumpy transition between an early, high-growth phase and a period of several years of more average, trend-like growth... [This] suggests that we should not be discouraged this time around by an uneven transition from rapid to more sustainable growth.

Some observers have called this extraordinary behavior of the housing market in recent years a bubble. I don’t find that term useful or particularly accurate, since the behavior of housing appears to have been based on solid fundamentals. 

First, there were good reasons for the homeownership rate to rise and for homeowners to spend more on housing...People base their investment plans on current and anticipated income growth, and it is not surprising that households would move increasingly from renting to buying their own home.

Second, inflation fell to below 2 percent in the mid-1990s, and over time, financial market participants became more confident that inflation would remain low and stable; that confidence, in turn, led to low mortgage interest rates.

The November inflation reports, however, have provided some tentative evidence suggesting a moderating trend. For example, the three-month average rate of change in the core PCE price index fell to 1.8 percent in November. That inflation measure has exhibited substantial oscillations, however – it fell to 1.8 percent in February of last year before rising to 2.9 percent within three months when energy prices surged. In view of the recent record, it will take several months worth of data to provide statistically convincing evidence of a moderation in inflation. In the meantime, the risk that core inflation surges again, or does not subside as desired, clearly remains the predominant macroeconomic policy risk.

Let me add a footnote here regarding wage rates and the inflation outlook. Some observers have viewed robust wage growth as a cause of inflationary pressures; I do not share that view. We can have healthy wage growth without inflation as long as we see commensurate growth in labor productivity... I would note that the rate of growth of productivity shifted higher beginning in the middle of the 1990s, and while productivity is hard to forecast, I believe that reasonably strong productivity gains will continue and will warrant reasonably strong real wage gains. What would concern me – and we have not seen this as yet – would be a persistent increase in wage growth that was not matched by a commensurate increase in productivity growth. Ultimately this would result in higher inflation.

I don't think policy is restrictive, and in fact I see that policy is, if anything, somewhat accommodative.

In a Market News interview

The broader lesson to take away from this Report is that inflation dynamics have evolved significantly over the last 50 years, and inflation expectations appear to be forward-looking. To again paraphrase the late Milton Friedman, inflation is always and everywhere an expectational phenomenon.

The Report does not say that inflation expectations are unimportant to the determination of inflation — their calibration exercise argues exactly the opposite, in fact — only that our available measures provide imperfect indicators. The stability of expectations measures, the authors argue, might mask potential instability in actual inflation expectations. With this I wholeheartedly agree; as I noted a moment ago, one can see measures of inflation expectations as in some sense "anchored" without being either satisfied with where they are anchored or sanguine about their stability.

But there is uncertainty and then there is uncertainty. I am fairly confident that the public places an extremely low probability on the Federal Reserve allowing inflation to average 10 percent over the next decade...  On the other hand, I suspect that market participants place some probability on inflation remaining at around where it is now — a 2 ¼ percent core PCE price index, for example — rather than moderating to 1 ½ percent. In that sense, one might question whether inflation expectations are anchored close enough to the price stability shore. Three-quarters of a percent might seem like a relatively small difference in inflation rates, but sustained over a decade or two, it would amount to a material difference in purchasing power.

Some observers have suggested that the decline in measured persistence implies that inflation will moderate more rapidly in the next year or two than would otherwise be the case.  The model calibrations reported here, however, demonstrate the extent to which the autocorrelation properties of inflation depend on how monetary policy is conducted.  This implies that policymakers should be quite wary of interpreting the fall in persistence since the 1980s as something monetary policy can exploit.  If persistence has declined because policy now responds more strongly to inflation, for example, achieving a more rapid moderation in inflation may require tighter policy.

While it may be too soon to declare this research issue entirely settled, my sense is that the preponderance of empirical evidence suggests that price setting is predominantly forward-looking.

I have spoken elsewhere of the secular expansion of consumer credit, including mortgage credit, and have argued that it has been the result of a broad wave of innovation.  The evidence strongly suggests that most of this expansion of credit can be accounted for by falling transaction costs associated with lending and borrowing. ... The cost reductions that have driven the growth of consumer credit can best be understood as the result of improvements in the ability of lenders to collate and analyze information about consumers, which in turn has allowed lenders to differentiate more finely among borrowers.  As innovations progress, the allocation of credit moves "down the demand curve."  The new borrowers brought into the market by these developments will, on the whole, have higher than average risks.
 

To paraphrase the late Milton Friedman, inflation is always and everywhere an expectational phenomenon.  To put it another way, inflation expectations are an outcome of monetary policy, not an autonomous help or hindrance.  Central banks are as responsible for the behavior of inflation expectations as they are for the behavior of inflation.  

It's fairly clear that adopting an explicit empirical objective for inflation is within the Fed's mandate.

From audience Q&A, as reported by Bloomberg News

If inflation doesn't moderate, I believe additional firming would be needed... 

Moderating growth doesn't reduce inflation.  Central banks reduce inflation.

As reported by Bloomberg News

"I think the current funds rate has us on track to achieve what we want," Lacker told reporters after a speech.   I am comfortable with the funds rate where we are now," he said.

As reported by Dow Jones News

[I]n many countries inflation expectations seemed to shift when the central bank adopted inflation targeting. Public understanding of the central bank's long-run goals and of how the central bank would respond to various potential economic disturbances helps anchor inflation expectations.

An alternative perspective on savings and consumption is that the strong recent growth in household spending indicates optimism about future income prospects, rather than any fundamental recklessness. The labor market is reasonably tight, with the unemployment rate at 4.5 percent. Earnings are growing at about a 4 percent rate. The working age population is growing at a 0.9 percent annual rate, and payroll employment has grown significantly more rapidly, at a 1.6 percent rate for the last few years. While employment growth won't be above average forever, prospects for real income growth look pretty solid. Moreover, household net worth is up to 5¾ years of disposable personal income, and has been rising during this recovery, which suggests that savings, properly measured, might not be so low after all.

A variety of expectations measures then, point to expectations for core PCE inflation of about 2 percent right now. What does this imply about the outlook for actual inflation, which is now running at about 2¼ percent? The current level of inflation expectations is likely to exert a gravitational pull on actual inflation, if monetary policy actions are not inconsistent with those expectations and no concerted effort is made to shift expectations...

Could inflation fall below 2 percent, say to 1½ percent? That depends. Without a prompt fall in inflation expectations, a reduction in inflation below 2 percent is likely to be temporary and hard to sustain. With expectations left alone, the remaining mechanism for bringing down inflation is the traditional Phillips curve mechanism, that is, an increase in real interest rates that slows aggregate demand and reduces both inflation and real activity...

The prospects for bringing inflation down below 2 percent thus hinge on the extent to which a reduction in inflation expectations can be brought about. How difficult would that be? Using changes in the target interest rate alone, the process is likely to be difficult and time-consuming...

One natural approach to bringing inflation expectations down more expeditiously, should that be the desire, would be a strategy of clear communications about policymakers' intentions.

[On housing] we're pretty close to a bottom in terms of demand, but there are some risks to that outlook.

As reported by Bloomberg News

If (profit margins) remain relatively high and unit labor costs continue to advance at or above 2 percent, then we are likely to see inflation continue at about 2 percent.

But given the repeated swings [in inflation] we've seen, it is difficult to pick out a definite trend, and in fact, no statistically significant moderating trend has emerged yet.

Over the three years leading up to 2006, real growth in the U.S. economy was relatively rapid, and inflation remained relatively low and stable. Over the course of 2006, though, both those numbers deteriorated a bit. Growth dropped below 3 percent, and in fact was closer to 2 percent in the last half of the year. Meanwhile, inflation moved above 2.5 percent. While still relatively low by historical standards, I view that number—and, more importantly, the upward trend in inflation—with some caution. Inflation is, in my opinion, too high.

The history of the Phillips curve has three distinct phases: the Phillips curve as a stable menu of policy options; the Phillips curve as a short-run relationship that depends crucially on people’s expectations; and the Phillips curve as one piece of a larger model that describes the complicated interactions of the decisions made by diverse participants in the economy.  While this last phase may sound impractically complex, we believe it offers a clear understanding of macroeconomic behavior and a useful way to frame current policy debates.

For instance, in the wake of Hurricane Katrina in late 2005, markets’ immediate response to rising energy prices suggested expectations of persistently rising inflation. Market participants, it seems, were uncertain as to how much of a run-up in general inflation the Fed would allow. Inflation expectations moved back down after a number of FOMC members made speeches emphasizing their focus on preserving low inflation. This episode illustrates both the potential for the Fed to influence inflation expectations and the extent to which market participants are at times uncertain as to how the Fed will respond to new developments.

 ...  [M]y position is that if government is going to invest in education at all, it should invest in enhancing early childhood development. For me, this is an economic growth issue. The continual enhancement of skills over time is essential to sustained growth in economic well-being, and research indicates that early childhood development is critical to the life-long development of skills.  

The most plausible downside risk is that financial market developments will lead to higher mortgage rate spreads and will further depress housing activity.

I believe there are still reasons to remain concerned about the risks to the inflation outlook. First, there are indications that the recent improvement may have been transitory, and that we may see inflation remain at this level, or perhaps even move up again. Second, the public's expectations of future inflation – an important determinant of inflation trends – appear to be inconsistent with further reductions in inflation.

Business investment faltered late last year, with weaker sales of autos and construction materials apparently playing important roles. Most of the fundamentals for business investment are still quite positive, however; profitability is high and the cost of capital is still fairly low, despite recent financial market developments. Thus investment could well maintain momentum this year, I believe, and we have been seeing some favorable signs.

Financial market volatility, in and of itself, does not require a change in the target federal funds rate, in my view. Interest rate policy needs to be guided by the outlook for real spending and inflation. Financial turbulence has the potential to change the assessment of the appropriate rate if it induces a sufficient revision in growth or inflation prospects.

``If evidence arrives that we need a policy move, of course I will consider it and I will take that evidence seriously,'' he said in an interview with Reuters today. ``That evidence would be of the nature of information that alters the outlook for real spending and inflation.''

``If it lowers growth and real spending, that is going to warrant a lower path for real interest rates,'' Lacker said, adding the impact is `` very unclear.''

As reported by Bloomberg News  

 But my reading of the evidence is that the episode was less about liquidity than it was simply about a dramatic change in the valuation of a class of credit exposures. Even with the Fed's reduction in the spread between its federal funds target and its primary credit discount window rates, and its encouragement to banks to come to the window, the amount of borrowing did not rise very much. So I think there's a good chance that, when all is said and done, we will be able to say that the Fed did the right thing. We stood ready to lend — on good collateral at a penalty rate — but did not interfere with the market's assessment of risks. 

I expect growth to be very weak for several more months, but to improve as we move through 2008. So if I had to guess – as my host, Henry, insists – I would write down that real GDP growth will be between 2 and 2 ¼ percent from the fourth quarter of 2007 to the fourth quarter of 2008.  

Since August, however, the inflation picture has deteriorated. In September and October, the overall PCE price index rose at a 3.3 percent annual rate, and the core index rose at a 2.6 percent rate. Judging by the closely related consumer price index, the numbers for November will be even worse. Now these numbers do display transitory swings, so I wouldn't extrapolate them forward indefinitely. Still, I have to say that I am uncomfortable with the inflation picture, and disappointed that the improvement we saw earlier this year was not more lasting.

I am also troubled by the lengthy divergence we've seen between overall and core inflation. Some of you may recall that core inflation was devised in the 1970s to filter out some of the more volatile consumer prices to get a better read on inflation trends. For several decades, core inflation seemed to work well due to the fact that food and energy prices had no clear trend relative to the overall price level. In the last few years, though, overall inflation has been persistently above core inflation, and few observers expect oil prices to go back below $20 per barrel. Because the job of a central banker is to protect the purchasing power of currency, it is overall inflation that we need to keep down, not just core inflation. Going forward, markets expect oil prices to back off slightly from their current level, and I hope they are right. If energy prices fail to decline, monetary policy decisions will be that much more difficult in 2008.

"It's not clear that this facility will address fundamental issues in inter-bank markets such as constraints on balance sheets, the need to raise capital and, importantly, concerns about counterparty risks," Lacker told reporters after a speech in North Carolina.

As reported by Dow Jones

Putting it all together, I expect growth to be very weak for several more months, but to improve toward the end of this year. Clearly, the most cogent risks to the growth outlook are on the downside. With the strains in housing persisting, a substantial slowdown in business spending could raise the odds of a recession. This risk would be heightened if December's job market weakness proved persistent, pulling down prospects for personal income and household spending. Nevertheless, I believe the most likely outcome is for growth to continue and to improve. I should note that my baseline outlook does not depend on an overly sanguine view of financial market conditions, which are, after all, a significant source of uncertainty right now.

This does seem like a slowdown that so far hasn't been that preventable and I think what we're going to get this year is going to be slower growth that is going to be difficult to completely counteract. So I think it's useful not to be too optimistic about the magnitude of the potential effect for fiscal stimulus, even if it's useful.

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

I have to say that I am uncomfortable with the inflation picture, and disappointed that the improvement we saw earlier this year was not more lasting.

I am also troubled by the lengthy divergence we've seen between overall and core inflation. Some of you may recall that core inflation was devised in the 1970s to filter out some of the more volatile consumer prices to get a better read on inflation trends. For several decades, core inflation seemed to work well due to the fact that food and energy prices had no clear trend relative to the overall price level. In the last few years, though, overall inflation has been persistently above core inflation, and few observers expect oil prices to go back below $20 per barrel. Because the job of a central banker is to protect the purchasing power of currency, it is overall inflation that we need to keep down, not just core inflation. Going forward, markets expect oil prices to back off slightly from their current level, and I hope they are right this time.

I think it [the first January TAF auction] suggests that the funding pressures that raised interbank funding rates in mid-December have eased substantially.

From press Q&A, as reported by Market News International.

A slowing economy requires a lower real interest rate because it means softer relative demand for resources now compared to the future. And the current downside risks mean that further slowing, and thus further easing, is quite possible. But inflation also presents risks. Throughout the period since 2005, when inflation rose, eased off, then rose again, longer-term inflation expectations have remained fairly stable. If energy and food prices continue to push overall inflation above core inflation, then this higher overall trend could work its way into expectations, further complicating monetary policy in 2008.

In the past it's been difficult to reverse field quickly when it seems warranted. And if that's going to be the case than it needs to affect how you approach things entering the period.

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

Inflation expectations seem to be fairly contained right now. The upward movement we see does not at this point seem to be likely to result in runaway inflation.

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

I always stand ready to cut rates when it is appropriate.  The incoming data over the last several weeks has certainly made me willing to contemplate rate cuts. It has certainly altered the outlook.

From press Q&A, as reported by Bloomberg News and Market News International

VICE CHAIRMAN GEITHNER. I really couldn’t tell, President Lacker, what inference you were going to draw from that. But I would just reinforce the point that, if you are more worried and uncertain now about the magnitude of the headwinds and the duration, I think it has to mean that you err on the side of going lower sooner. But the main point is that we just don’t know much about it, and I think it is worth a lot of humility. I mean, think how surprised we have been by so much over this period, even with all our thinking through three years ago about alternative paths for housing. So I would just vote for humility. But the basic point is that we have to err on the side of being worried about reducing the risk that you end up with 75 mile an hour headwinds rather than 25 for a long period of time.

….

PRESIDENT LACKER. Our Vice Chairman urges humility. I strongly support that. I agree with President Evans that it’s not obvious that the greater one’s humility, the greater one should favor ease. I think we should be humble about the path of inflation going forward, whether it’s likely to fall on its own. I think we should be humble about our understanding of the output gap. I think we should be humble about whether that’s even a sensible way to think about how real and monetary phenomena interact. The Phillips curve itself embodies a relationship. It is uncertain, but it embodies expectations of our future behavior. I think we should be humble about what those expectations are in the present circumstance. Times in the past when we’ve gotten in trouble on inflation have often been when we were over-solicitous about weak economic growth, and I think we should be humble about whether we’ve completely gotten past those inflation dynamics or not. I think we should be humble about the willingness of our future selves to reverse course, and a lot has been said about that. For some it seems to counsel greater ease now, but I think the opposite argument can be made that the extent to which we think we may be hindered or feel impeded in raising rates, even if we think it’s warranted in the future, should cause us to be more cautious about lowering rates now. It always seems in recoveries that there’s always something that looks fragile, that looks likely to threaten economic growth. You know, one month it will be the commercial paper market and CDO writedowns, and this month it’s monolines. There will be headwinds. I predict we’ll be talking about headwinds a fair amount in the next couple of years. But if those are genuinely going to impede us, we need to be realistic about that, and I think we need to take it on board now. I agree with President Poole. We need to be humble about our ability to prevent a recession. I think we should also be humble about the extent to which what we see in terms of both growth and financial markets is presumptively inefficient and needs remedial action on our part. You spoke several meetings ago, I think a year or two ago, Mr. Chairman, about our need to retain a concern about inflation but not be seen as inflation nutters. I think we need to care about financial fragility but not be fragility nutters.

It's a temporary program. Personally I don't think it would be advisable to make it a permanent feature of the way we manage reserves and conduct policy. I think we have adequate tools without it.

From press Q&A as reported by Market News International

I think for the next several month's there'll always be a chance that a shoe's going to drop. It induces portfolio shifts and financial
sector adjustments ... I don't think that the magnitude of shocks is likely to be big enough to threaten the financial system in a material way. And I think the magnitude of issues is likely to decline over time, if they occur. But you can't tell what you don't know. Unexpected stuff can always happen

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

I'll just speak for myself. It wasn't - the bond insurers were not an important factor for me. The week before we just got a slew of adverse real news, and that was the predominant consideration in my mind for that intermeeting move.
 
In response to a question about the role that bond insurer problems played in the FOMC’s decision to ease on January 22.  Unofficial transcript.

Chances are that [a fiscal stimulus package] would just pull growth from the future, so that would mean more growth late into '08, less growth in early '09. The economy, in terms of the size of economic activity, would probably be in late '09 about where it would be otherwise.

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

Lacker said he hasn't noticed a change in the way dissents are viewed under Bernanke, compared to previous Fed chief Alan Greenspan. "I haven't sensed any shift in that regard," Lacker said.

Because the Fed faces significant inflation risks as well as economic weakness, FOMC members may have differences of opinion about the best policy response. Lacker said the Fed's discussions tackle those considerations responsibly. "A lot of people have remarked he [Bernanke] has a very collegial style. I think the committee's quite cohesive in its functioning," Lacker said.

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

As I said, my sense is that the most likely path is sluggish growth in the near term. But I can also see the possibility of a mild recession, similar to the last two we have experienced — in other words, shallow and with a slow recovery. What I don't expect is a more severe recession, like those we saw in 1982 or 1974. Keep in mind that monetary policy has moved aggressively in recent months, and that inflation-adjusted interest rates are now very low by historical standards. That by itself won't solve all our problems, but it will help support activity enough to at least avoid the worst outcomes, and possibly avoid a recession altogether.

When energy prices go up, it pushes inflation up, and we face a choice whether to counteract that or not. When the futures market's telling you that they're going to flatten out, it doesn't look like there's as much to counteract. But we've been surprised on the positive side by energy prices for four years in a row now. At some point you just have to ask the question of whether the futures markets are a reliable guide and whether we need to do more to offset the effect of energy prices on the overall level of inflation.

From press Q&A as reported by Market News International

The economic outlook for 2008 has worsened in response to the developments of the last six months, and the recent flow of data has heightened the downside risks.

The housing sector has been and will continue to be affected by the tightening we've seen in lending standards. New home sales have fallen 64 percent from their peak in October, 2005. Home construction is unlikely to bottom out this year, and I expect housing investment to continue to be a drag on growth through at least year-end.

In my view, the prominence of downside risks means that further easing ultimately may be warranted. My expectation that growth is likely to be sluggish this year figured prominently in my thinking about policy last month, however, so if incoming data is not weaker than expected over the next several months, it's not clear further rate cuts would be warranted.

Exports are likely to remain a source of strength next year, however, as a weaker dollar and continuing growth abroad support demand for U.S. goods and services. Accordingly, I expect the trade deficit to continue to narrow, providing modest support to real GDP growth.

There is a fair amount of month-to-month volatility in the employment numbers, so it is quite possible that the underlying trend is stronger than the January reading by itself would suggest. If job growth is positive in the months ahead, and if wages can stay ahead of inflation, then income growth should be sufficient to support consumer spending gains and allow us to skirt the boundary of recession.

It looks like we're going to get growth of 0.5% perhaps in the first half of the year and then later in the year growth firming, and increasing and after about a couple of years back to our long-run trend (2%-3%). That's what I think is most likely.

From conversation with students and faculty as reported by Market News International.

Lacker was asked whether the trading losses at French banking giant Societe General would impact the U.S. economy: "I don't think it's going to have an effect."

As to whether the scandal influenced the Fed's recent rate cuts, Lacker added, "I don't think it affected our policymaking at all."

From conversation with students and faculty, as reported by Market News International

Inflation is a problem now. It is too high and personally I would be uncomfortable in waiting for economic slack to bring it down.

...

I am particularly concerned about movements in measures of expected inflation.

From comments to press, as reported by Reuters

I think there are important questions on the table about the structure of regulatory authority and responsibility at the national (level).

But no matter how that comes out, I think the structure of the Federal Reserve system has served this country very well and in my view it ought to be preserved.

From comments to press, as reported by Reuters

It is important not to get wrapped up in dancing on the head of a semantic pin.

I am expecting a contraction in economic activity in the first half of this year. And whether the NBER (National Bureau of Economic Research) decides it is a recession ... I am willing to wait.

From comments to press, as reported by Reuters

Looking at our record over the last 4 years of inflation that has fluctuated between just below 2 percent and (above) 3-1/2 percent, the danger in that pattern persisting is that people might become accustomed to it, and come to expect inflation to continue at rates greater than we would like to see. ...

A deterioration of inflation psychology is a major concern because it is very difficult to unwind.

From comments to press, as reported by Reuters

No matter what the short-term benefits of that action were, or the other credit market interventions that we have undertaken, there is undoubtedly a risk of adverse incentive effects down the road and perhaps even in the near term as well.

From comments to press, as reported by Reuters

Lacker expressed skepticism about declines in various gauges of consumer confidence or consumer sentiment. He called them "kind of crude measures" and said "it's hard to make anything out of them."

"Sometimes they dip sharply without any deflection in the path of consumer spending," he said, while "sometimes they are a harbinger of significant (slowing) of consumer spending."

From comments to press, as reported by Market News International

It looks like we're in the midst of a contraction. [He said he is] expecting a contraction in economic activity
in the first half. ...

It's not over yet. I don't think it's going to end all at once.

I think the crucial variable is stability in the residential housing market in a broad number of geographies that we can have some confidence about our sense of where housing prices are going. The other major source of uncertainty that I think is consequential is non-residential construction spending. And we'll just have to see how that plays out.

From comments to press, as reported by Market News International and Reuters

Inflation was disappointing as well last year. The price index for personal consumption expenditures rose by 3.6 percent during 2007, compared to 2.3 percent the year before. Rapid increases in food and energy prices were the obvious culprits, but that provides little comfort to this central banker. The Federal Reserve is responsible for keeping total inflation low and stable—including food and energy prices. While the effects of unexpected commodity price increases are difficult to offset rapidly, an appropriate monetary policy would ensure that such shocks even out over time and do not impart a persistent inflation bias—either up or down.

The dramatic recent expansion in Federal Reserve lending raises the possibility that market participants view future access to Fed credit as having been substantially broadened. For evidence, market participants could point to the fact that entities formerly viewed as unlikely to have access to the discount window, such as the primary dealer subsidiaries of investment banks, have now been granted access...In my view, there is value in communicating policy intentions clearly. Deliberate imprecision — the so-called "constructive ambiguity" approach — leaves it to market participants to draw inferences for future policy from our past actions. Without an articulated statement of intention regarding lending policy, the time consistency problem is likely to be a difficult challenge because it will be hard to resist the future temptation to mitigate financial market stresses when they arise.

Beyond that, the central bank's historical role as a lender of last resort places it squarely in the center of financial disruptions as they unfold. We are perhaps not as close to a consensus on the proper conduct of this role as we are with regard to price stability. But as we continue to learn about the causes and nature of financial instability, I believe we should strive for policy that is informed by the lessons learned in the achievement of price stability. Chief among those is that a central bank can achieve better outcomes if it can establish credibility for a pattern of behavior consistent with achieving its long-term goals.

 Most lenders have eliminated many riskier innovative mortgage products from their line-ups, which makes sense given the recent performance of such products, but which makes homeownership more costly than it was during the boom. Thus, most observers are very hesitant about calling a bottom in housing construction, sales or prices. And even if housing market activity does manage to bottom out later this year, it is likely that any recovery would be exceedingly slow.

Business spending on equipment and software has also been firmer than I expected...The sense I get from our contacts is that most organizations have a large menu of options to improve and rationalize their information technology infrastructure and business processes in valuable ways, and they foresee a continual stream of spending on such projects.

Competitive trading markets are impressively effective mechanisms for weighing and amalgamating widely divergent views, and so one shouldn't ignore the information embodied in market prices, and I don't. The implied forecast misses have been predominantly on the high side in recent years, however. The risk for inflation dynamics is that elevated rates of increase in overall price level become embedded in expectations.

Part of the rationale for the speed with which the FOMC brought down the funds rate was the risk that the slowdown we are experiencing would prove to be more severe. While that uncertainty has not entirely disappeared, my sense is that such downside risks have diminished appreciably. And just as easing policy aggressively in response to emerging downside risks made sense, withdrawing some of that stimulus as those risks diminish makes eminent sense as well. Moreover, our attention to risks needs to be two-sided, I believe. As we move through this period of low growth, we need to be attuned to the risk that we emerge from the slowdown with inflation following a higher trend than when we went in. This danger associated with the persistence of elevated inflation warrants an additional measure of vigilance.

"The weakening dollar factors into our sense of economic growth and inflation," Richmond Federal Reserve Bank President Jeffrey Lacker told an audience after giving a speech here.

"In the current environment, the extent to which it has added to inflationary pressures, particularly with commodity and energy prices, is definitely a prime risk on our minds.

"What we're going to do about it is conduct policy the way we always have, which focuses on domestic inflation," he said.

...

Lacker, voicing long-standing views of the Richmond Fed and many others in the economics' profession about the unwelcome consequences of interfering with markets, made plain he would be reluctant to support {foreign currency intervention}.

"I think foreign currency intervention by central banks is a mistake...as a matter of general policy," he told reporters after the speech.

As reported by Reuters

There are no signs now of a wage-price spiral, with wages accelerating in a futile attempt to stay ahead of accelerating prices. In fact, gains in overall compensation have been remarkably stable over the last couple of years.

I have followed the economy closely for much of my professional career and have learned two important lessons that are relevant today. First, don't underestimate consumer resilience....And second, don't underestimate the power of monetary policy.

MR. LACKER. Yes. I notice that in chart 18, in your TIPS-implied average inflationary plot to the ten-year horizon, you omit the Markets Group’s estimate. Is that because of skepticism on your part that leads you to judge it as inferior or an overabundance of humility? [Laughter]

MR. DUDLEY. The latter, of course. [Laughter]

MR. LACKER. It does, of course, show a slightly different trend, right?

MR. DUDLEY. It actually has increased a bit. But I have consistently shown just the Barclays and Board measures over the past few months, so this is not “pick and choose.”

Most observers are very hesitant about calling a bottom in housing construction, sales or prices, a hesitancy that I share. And even if housing market activity does manage to bottom out later this year, it is likely that any recovery would be exceedingly slow.

Business spending on equipment and software this year has also been firmer than I had anticipated. For example, shipments of non-defense capital goods, excluding aircraft, have increased for three straight months, and are now higher than at any point since December 2000. This category covers a large part of business equipment investment and recent reports indicate that business capital spending is holding up relatively well.

Earlier this year, many observers extrapolated this slowdown into an outright decline in economic activity and concluded that the economy was in or about to enter a recession. But the data we've seen since then have not yet shown the sharp, widespread reversals that define a recession. While the risk of an acute near-term downturn has not entirely disappeared, it has diminished substantially.
...
I expect growth to be positive, but quite modest for the rest of this year, and to gradually pick up over the course of next year. Although the downside risks to growth are by no means negligible, they have diminished significantly to my mind since the beginning of the year.

While the growth outlook has improved since the beginning of the year, the inflation outlook has deteriorated. The latest figures confirm that inflation is unacceptably high. The price index for personal consumption expenditure increased 3.1 percent over the 12 months that ended in May, and is up at a 3.9 percent annual rate for the last 3 months. To put that in perspective, for several years, I have suggested an inflation target of 1.5 percent.

Part of the rationale for the speed with which the FOMC brought down the funds rate was the risk that the slowdown we are experiencing would prove to be more severe. While that uncertainty has not entirely disappeared, my sense is that such downside risks have diminished appreciably. And just as easing policy aggressively in response to emerging downside risks made sense, withdrawing some of that stimulus as those risks diminish makes eminent sense as well. Moreover, our attention to risks needs to be two-sided, I believe. As we move through this period of low growth, we need to be attuned to the risk that we emerge from the slowdown with inflation following a higher trend than when we went in. This danger associated with the persistence of elevated inflation warrants an additional measure of vigilance.

"We can't sustain inflation at this pace," Lacker told reporters following at the Richmond Fed's Charlotte branch. "Moderation in growth by itself isn't likely to bring down inflation dramatically."

As reported by Reuters.

Although widely used economic barometers haven't yet signaled the formal beginning of a recession, there is a chance one lies ahead, Federal Reserve Bank of Richmond President Jeffrey Lacker said Tuesday.
...
"Even if we get through this energy price bulge and inflation moderates, I'm still concerned of the overall pattern we've set," he said.
...
Although risks to economic growth persist, Lacker said, "For us to lose substantial ground on inflation would be much more costly for us to remedy than for us to have to face a more substantial slowdown in growth than we've seen so far."
...
"A 2% federal-funds rate with overall inflation running at 4% is an exceptionally low real interest rate - lower than we've had in the post-war record," he said. "Monetary policy seems quite stimulative to me on that basis."

It's going to depend on your forecast for that. So it's difficult to argue against futures markets that have a certain view built in that energy prices are going to, crude oil, for example, is going to be flatter down from here. But they've been wrong before, and there's a huge band of uncertainty around that central tendency of a forecast. So I think the most likely outcome is moderation in headline inflation over the next half year or year. Core inflation likely to rise to 2.5 percent or so. And I think it will moderate after that.

It's a tough, tough choice as a policy maker. It's always tempting to think, ``Well, I know where this is going to go, let's just smooth out the path and get it there.'' Or to come to the judgment that things are overshooting and they've really gone too far. But I tend to have some respect for market processes in times like this. And I like to approach this with some humility about policy makers' ability to asses where mortgage backed securities should trade, just as we were genuinely humble about what we could say about where tech stocks should trade through.

{Constructive ambiguity} is a phrase that's been used often in central banking circles. And I think it's most often associated with the idea that you should hold back communicating what circumstances under which you're willing to lend or intervene, and allow market participants to be uncertain about what those circumstances are. I think that the objective of, the argument I've heard for constructive ambiguity amounts to having two things at once. Having the discretion to intervene, but trying to convince markets that you won't.
...
If you intervene, it's going to involve some moral hazard. Moral hazard's going to be the greater the greater the probability people expect you to intervene. So you'd like to minimize moral hazard. So you'd like them to think you're not going to intervene. At the same time, when the time comes, and some crisis emerges, you would like to have the discretion to intervene. So I think of constructive ambiguity as an attempt to have it both ways, to try and get people to behave as if you're not going to intervene, but to retain the discretion to intervene.

{In reference to separating the Fed from other institutions by adding responsibilities} I think it's likely to emerge as a theme. I think it ought to be front and center in the discussion about financial regulatory reform and restructuring if Congress would like to go down that path, restructuring regulatory responsibilities at the federal level. Our paramount responsibility is keeping prices stable, inflation low and steady. There are other responsibilities we have accumulated over the years. And we have, as a result of our history, where we came from, and various responsibilities that have been given to us. But our ability to exercise independent judgment about the level of the policy rate, I think, is quite important. And I do see some merit to the argument that adding responsibilities can threaten to dilute the independence that we need for that responsibility.

{The debate over rules and descretion} is always on our minds. And for me, in the present circumstance, it arises in how you calibrate your concern about growth. Real interest rates have to fall when growth slows, but you want to communicate that you're not using your discretion to just shift your attention from one objective to the other. It's important for people to know that we're maintaining a continual focus on inflation. It's just that the state of the real economy justifies lowered growth now. You don't want it to be interpreted as we're throwing inflation overboard for a few months while we worry about growth. So it's letting people know that we're following what we view as a time-consistent strategy to commit to keeping inflation low, and that we're not just acting on a purely discretionary basis.
...
The Taylor Rule has proved incredibly useful as a very convenient way of summarizing algebraically and approximating in a fairly impressively good way, the way central banks behave. But keep in mind that Taylor Rule is a function of just things you can observe. Actual realized inflation recently. And what it leaves out are a lot of things policy makers can observe. What their forecast is, what's going on in oil markets, a lot of other data that go into our thinking, and that can affect our sense of how the economy's going to evolve. And those things, in turn, affect our policy setting. That doesn't mean we throw the Taylor Rule overboard. On the contrary. It's something that you want to deviate from only with good reason and only being very careful. And the farther you get away from it, the more you have to kind of check yourself as to whether you're really on solid ground or not.

I think we're in for an episode where the rate of which banks fail is likely to increase. Of course it's been exceptionally low in the last few years, so it shouldn't, I don't think it should concern us.

Lacker said, however, that the Fed's monetary policy stance is "positioned well for where we are right now," though he admitted he wasn't so sure a few months ago.   "In the middle of the year, I had concerns about where we were for policy, but the weakening in growth we’ve seen in the last couple of months makes me more comfortable about where policy is right now."

As reported by Dow Jones Newswires

Many analysts expect the U.S. economy to regain positive momentum sometime in 2009. That strikes me as a reasonable expectation, for several reasons. First, monetary policy is now quite stimulative. The federal funds target rate is 1 percent, below the expected rate of inflation. Second, the major shocks that dampened economic activity this past year have already subsided or are in the process of doing so. Energy prices, thankfully, have reversed most of the earlier run-up; that will free up a portion of consumer budgets for spending on other goods and services. And as I've mentioned, the drag from housing seems likely to lessen in the next year, and in fact, I would be surprised if we don't see a bottom in housing construction around the middle of 2009. This is the third straight year, however, that I've been expecting a bottom in the housing market in the middle of next year, so my outlook is tempered by more than the usual amount of humility.
...
The sharp decline in oil prices since they peaked this summer has flattened the overall inflation rate in August and September. Many economists are forecasting a decline in core inflation as well in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. While this correlation is detectable in many datasets, I would be cautious about relying on it as a causal relationship.⁴ In particular, this relationship can shift over time as expectations about the conduct of monetary policy evolve. Those expectations will be influenced importantly by the measure of monetary stimulus provided during the downturn and how long that stimulus remains in place. As a recovery begins, the path of least resistance is often to hold the policy rate at a low level until it is completely clear that recuperation is complete. The risk associated with that path is that inflation may not moderate obediently during the downturn, and may firm with the ensuing recovery. It is crucial that we not allow expectations of future inflation to ratchet higher during this recession.

The conventional wisdom is that the credit market disruptions we've seen over the last year or so impede the financial sector's ability and willingness to extend credit to households and business firms, thereby creating an additional drag on spending. But causation can flow in the opposite direction as well. When overall economic activity seems poised to contract, the outlook for household income and business revenues deteriorates as well. This implies that individual households and businesses will become less creditworthy, all else constant.

...

My reading of the history of U.S. business cycles is that the direct effect of credit markets on real activity – the so-called "credit channel" – accounts for only a small part of the variation in output over the typical cycle. This judgment may be of limited help in thinking about the rather atypical events we have been experiencing recently, but I think it means we have to give serious consideration to the idea that this episode of credit and financial market turmoil is part of the economy's natural response to the sharp decline in the underlying fundamentals in housing finance. My sense is that the deterioration of economic conditions is playing a more prominent role in the tightening of credit terms right now than the direct effects of financial market turbulence.

Some economists have argued that tighter monetary policy during that period would have led to better outcomes by limiting the housing boom and thus mitigating the subsequent bust.² While I find this view plausible, again, further research will be required to substantiate this hypothesis.

Because households tend to base their consumption plans on their income prospects, any improvement in consumer spending growth likely will depend on a shift to a more optimistic assessment of those prospects. Once households are convinced that an end to the deterioration in labor market conditions and the fall in equity and home prices is in view, however, consumer spending growth will be based on improving longer-run income prospects and is likely to pickup substantially.

Lacker said he was not about to express any regret about letting Lehman Brothers fail, an event many analysts see as pivotal in the evolution of the financial crisis.

 "I am not going to second guess the decisions that have been made," he said, and he added he is giving his fellow policymakers the benefit of the doubt, assuming they made the best judgment given the information available at the time. 

 However, the subsequent confusion among market participants following Lehman's failure and the AIG bailout is something that all policymakers appreciate very deeply, he said. "I think that's what motivated the pursuit of a comprehensive solution," he said.

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

[I]t will not be sufficient when the recovery comes, to scale back our lending," he warned, even though it will be necessary.   "Unless we do something valid," he went on to say, "the lingering expectation will be that when the next crisis comes, a similar response will be forthcoming."   Scaling back such an expectation, Lacker argued, is the challenge "of our time."

From the audience Q&A session, as reported by Market News

Discussions of the role of the central bank as a lender of last resort often appeal to Walter Bagehot’s classic prescription: “Lend freely at a high rate, on good collateral.”⁶ But Bagehot’s teachings are not directly relevant to modern central bank lending. Lending by modern interest-rate-targeting central banks is by necessity sterilized. By itself, a central bank loan increases both the liabilities and assets of the central bank. The additional reserves would tend to drive the interest rate below the target, so central banks generally sterilize their lending operations via offsetting asset sales.⁷ In Bagehot’s time, however, unsterilized lending was the only way for the central bank to prevent a spike in interest rates by elastically increasing the supply of central bank money when the demand for it rose in a crisis. In other words, Bagehot’s dictum was about monetary policy — that is, the size of the central bank’s balance sheet — not credit policy, which alters just the composition of a central bank’s asset holdings.

The standard theory of financial markets is based on the notion that markets are a reasonably effective mechanism for aggregating dispersed information about asset fundamentals, so that changes in observed prices correspond to changes in markets participants’ beliefs about future payment streams... The limitations of the standard approach to asset pricing have led to the development of theories built on frictions that cause market prices to deviate from the standard results. Some of these theories have the implication that market performance might be improved by central bank lending or other official intervention.

One commonly cited market malfunction is based on coordination failures that take the form of bank runs, especially runs that have the self-fulfilling property that market participants pull their funds simply because they think that others are doing so...  My sense of the accumulated evidence is that it is hard to find examples of purely self-fulfilling runs — that is, runs not plausibly warranted by changing fundamentals.¹² Not all rapid portfolio shifts represent runs that necessitate official intervention. Moreover, financial entities often can protect themselves from runs by structuring their borrowing arrangements appropriately.

Another type of market imperfection is the notion that asset prices can deviate from their fundamental values when some participants are forced to sell their holdings rapidly (to meet a margin call for example) and are forced to take whatever price is offered, even a price that commonly is known to be much less than the asset’s true economic value...  In this age of integrated global financial markets, I find it hard to envision something — other than those investors’ doubts about the value of these assets — that has been artificially impeding investors’ entry into the markets for depressed assets.

A broader motivation for public sector support at times like these is the notion that credit market disruptions that reduce the banking sector’s capital can impede banks’ ability and willingness to extend credit to households and business firms, thereby creating an additional drag on spending and growth. ..  My reading of the history of U.S. business cycles is that the direct effect of credit markets on real activity — the so-called “credit channel” — accounts for only a small part of the variation in output over the typical cycle. And my reading of current conditions is that bank lending is constrained more now by the supply of creditworthy borrowers than by the supply of bank capital.

The striking feature of central bank lending during the recent turmoil is the extent to which it has extended well beyond the boundaries that previously were understood to constrain such lending, both in the range of institutions and the contractual terms on which credit has been provided. Intervention has been driven by a desire to prevent damaging disruptions to financial markets, and thus reduce the overall costs of the turmoil. While this objective is clearly understandable, central bank lending can create the expectation that similar support will be forthcoming when market disruptions occur in the future. Such expectations can themselves be very costly, because they can distort the incentives faced by, and as a result, the choices made by private-sector participants.

"We don't expect deflation," Richmond Fed chief Jeffrey Lacker told reporters after a speech to the Tech Council of Maryland.

With the federal funds rate at a low level of 1% and the economy weakening, many Fed watchers have begun to discuss other means of boosting the economy, also called "quantitative easing."

Lacker seemed confident that the Fed has sufficient ammunition, saying that the U.S. central bank has "a wide variety of choices" with which to conduct policy even if interest rates were lowered to zero.

"I don't see our inability to reduce the funds rate below zero as hampering our ability to make monetary policy," he commented.

As reported by Market Watch.

While the downturn in real economic activity is going to pose challenges for monetary policy in the period ahead, it’s essential that we not let inflation drift from view. Since 2004, overall inflation has trended upward, and has been higher than I would like, over the last few years. Much of the acceleration we saw earlier this year reflected energy prices, however, and with oil prices down we have seen overall inflation subside in recent months.

Many economists are forecasting relatively low inflation in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. While this correlation is detectable in many datasets, I would be cautious about relying on it as a causal relationship.⁵ And while it may seem premature to be worrying about how inflation behaves after the recession is over, we need to be sure our policy remains consistent with a strategy that does not allow inflation to ratchet up over the business cycle.

The critical policy question of our time is where to establish the boundaries around the public-sector safety net provided to financial market participants, now that the old boundaries are gone. In doing so, the prime directive should be that the extent of regulatory and supervisory oversight should be commensurate with the extent of access to central bank credit in order to contain moral hazard effectively.

Looking ahead, uncertainty about the outlook is greater than usual, though probably not greater than is typical for this phase of a business slowdown. It strikes me as reasonable to expect the U.S. economy to regain positive momentum sometime in 2009, for several reasons. First, monetary policy is now quite stimulative. Second, the energy and commodity price shocks that dampened economic activity earlier this year have subsided already or are in the process of doing so. And as I’ve mentioned, the drag from housing seems likely to lessen in the next year, and in fact, I would be surprised if we don’t see a bottom in housing construction sometime in 2009. This is the third straight year, however, that I’ve been expecting a bottom in the housing market in the middle of next year, so my outlook is tempered by more than the usual amount of humility.

Note that it will not be sufficient simply to roll back the current lending programs when the economy recovers. The precedents that have been set during this episode will influence how market participants expect policymakers to react during the next episode of financial market turmoil. Establishing a coherent and stable financial regulatory regime will require rolling back expectations about how the policymakers will respond to the next financial market disturbance. Rolling back those expectations will be impossible if moral hazard concerns are always set aside in the exigencies of a crisis.⁴

I do not believe that deflation is a major risk right now. But deflation can be dangerous because for any given interest rate, it increases the corresponding real (or inflation-adjusted) interest rate, and thus stifles growth. For a sustained deflation to emerge, people have to believe that the money supply will fall along with the price level.  That's what happened during the first three years of the 1930s, at the beginning of the Great Depression, when the U.S. consumer price index fell by 27 percent, and the monetary base shrank by 28 percent. Central banks can prevent deflation by credibly committing to keep the money supply from contracting. Such a commitment is a natural byproduct of a credible commitment to price stability, but for a central bank that has not yet formally adopted an inflation objective, preventing deflation can present additional challenges. This is why some central banks increase the quantity of their monetary liabilities dramatically when interest rates are at zero — to convince the public they will not let the money supply contract in the future.

(I)t strikes me as reasonable to expect the U.S. economy to regain positive momentum sometime in 2009, for several reasons. First, monetary policy is now quite stimulative and real interest rates are quite low. Second, the energy and commodity price shocks that dampened economic activity last year have subsided already or are in the process of doing so. And third, as I said, the drag from declining residential investment seems likely to diminish significantly in the next year. In fact, I would be surprised if we don’t see a bottom in housing construction sometime in 2009.

While the downturn in real economic activity is going to pose challenges for monetary policy in the period ahead, it’s essential that we not let inflation drift from view. Since 2004, overall inflation has trended upward, and has been higher than I would like over the last few years. Much of the acceleration we saw last year reflected energy prices, however, and with oil prices down, we have seen overall inflation subside in recent months. Moreover, many economists are forecasting relatively low inflation in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. I would be cautious about relying on this correlation as a causal relationship, however, even though it is detectable in many datasets.⁶ There have been times in the past when inflation declined only temporarily when activity slowed, and re-accelerated when the recovery began. And while it may seem premature to be worrying about how inflation behaves after the recession is over, we need to be sure our policy remains consistent with a strategy that does not allow inflation to ratchet up over the business cycle.

(I)t will not be sufficient simply to roll back the current lending programs when the economy begins recovering. The precedents that have been set during this episode will influence how market participants expect policymakers to react during the next episode of financial market turmoil. Establishing a coherent and stable financial regulatory regime will require rolling back expectations about how the policymakers will respond to the next financial market disturbance or the next recession. Doing so will be difficult. But rolling back those expectations will be impossible if moral hazard concerns are always set aside in the exigencies of a crisis.⁵

The proximate cause of the financial market turbulence, of course, is the home mortgages made from late 2005 through early 2007, near the end of long U.S. housing boom that began in 1995...

It will take years of research to untangle the quantitative contribution of various causal factors to the decade-long housing boom, the accompanying rise in subprime mortgage lending, and the subsequent increase in mortgage losses. A definitive assessment is too much to ask at this point, but a list of the most plausible suspects can easily be discerned. One candidate that is often overlooked is the significant increase in productivity growth, and thus growth in real household income, which began around 1995 and lasted until some time earlier in this decade...

Another plausible contributing factor was the wave of technological innovation in retail credit delivery, which allowed lenders to make finer distinctions between potential borrowers. This facilitated lower interest rates for some borrowers and an expansion of lending to borrowers formerly viewed as unqualified for credit...

The regulatory and supervisory regime surrounding U.S. housing finance also seems likely to have contributed to the boom in housing and housing finance. Here, several factors deserve mention...

Another key causal suspect is the relatively low path of interest rates after the recession earlier this decade, especially in 2003 and 2004. Some economists have argued, with the benefit of hindsight, that tighter monetary policy during that period would have led to better outcomes by preventing core inflation from rising, thus limiting the housing boom and mitigating the subsequent bust. This view strikes me as quite plausible, but again, further research will be required to substantiate this hypothesis.

The turmoil intensified in mid-September, and volatility has been elevated since. Financial market participants have faced three major categories of uncertainty. The first concerns the aggregate amount of losses on mortgage lending...

Second, financial market participants have faced uncertainty about where the losses will turn up...

Third, market participants have at times faced uncertainty about prospective public sector intervention.⁴ The disparate responses to potential failures at several high-profile organizations may have made it difficult for market participants to forecast whether official support would be forthcoming for a given counterparty. Shifts in expectations regarding official intervention may have added volatility to financial asset markets that already were roiled by an increasingly uncertain growth outlook. And uncertainty about the form of government support — asset purchases versus dilutive capital purchases, for example — may have hindered the provision of fresh equity capital.

The striking feature of central bank lending and other government financial support during the recent turmoil is the extent to which it has extended well beyond the boundaries that previously were understood to constrain such lending, both in the range of institutions and the contractual terms on which credit has been provided. Intervention has been driven by a desire to prevent damaging disruptions to financial markets, and thus reduce the overall costs of the turmoil. While this objective is clearly understandable, central bank lending can create the expectation that similar support will be forthcoming when market disruptions occur in the future. Such expectations can themselves be very costly, because they can distort the incentives faced by, and as a result, the choices made by private-sector participants. For example, in the past year, expectation of official support may have induced some firms to take the risk of turning down capital infusions or merger offers in hopes of finding better terms in the future. Prospective equity investors may have demanded stiffer terms to compensate for the possibility of dilutive government intervention.

Richmond Federal Reserve President Jeffrey Lacker on Friday called arguments to remove toxic assets from bank balance sheets "compelling."

"As long as you have some material risk that remains on the bank's books, any new equity investor is going to be subsidizing existing debt holders, and that's going to impose an impediment to raising new equity and recapitalizing the banking system from the private sector," he said, taking questions from reporters after a speech to the Richmond chapter of the Risk Management Association.

Lacker, a 2009 voting member of the Federal Open Market Committee, said he supports an idea floated earlier in the day by U.S. Treasury Secretary Henry Paulson to create some type of aggregator bank. "That general idea is a very good one," he said. "It has a lot of promise for the way forward."

In comments to reporters after his speech, as reported by Dow Jones News

Mixing monetary and fiscal policy is fraught with risks. Many historical instances of monetary instability have been the result of central banks being prevailed upon to use their balance sheets for fiscal ends in ways that impeded their ability to keep inflation under control. That is why in recent decades, countries around the world have provided a measure of independence to their central banks, within frameworks that ensure accountability, in order to explicitly insulate them from short-run political exigencies that might diminish the credibility of their commitment to control inflation. The cornerstone of that framework in the United States dates back to 1951, when the Treasury-Fed Accord formally gave the Federal Reserve independent control of its balance sheet.⁸

...While at the present time, credit programs do not conflict with our monetary policy strategy, there could well come a time at which monetary stimulus needs to be withdrawn to prevent a resurgence of inflation, even though credit markets are not deemed fully healed. At that time, containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them. Price stability, after all, is the vital first ingredient in financial market stability.

"If you compare buying Treasuries to a targeted credit program, the targeted credit program will result in probably lower interest rates in the targeted sector, but higher interest rates in the other sectors."

...

"I would have preferred a program of buying Treasuries over targeted credit programs like the Term Asset-Backed Securities Lending Facility", Lacker said. He said he would not be opposed to the purchase of long-term Treasury securities such as 10-year notes and 30-year bonds.

As reported by Bloomberg News

Central bank independence is now widely recognized as an important mechanism for insulating monetary policymaking from inflationary political pressures, and allowing it to respond quickly to short-run macroeconomic developments.

This observation led my former colleague, Marvin Goodfriend, to argue 15 years ago for transferring much of the Fed’s lending activities to the Treasury. He wrote:

“Congress bestows such independence only because it is necessary for the central bank to do its job effectively. Hence, the presumption ought to be that the Fed should perform only those functions that must be carried out by an independent central bank.”¹⁰

While both the Fed and the Treasury can extend credit, only the Fed issues money. Thus, the Fed’s primary focus should be the management of its monetary liabilities.

Goodfriend advocated an understanding or agreement between Fed and Treasury on credit policy, analogous to the 1951 Accord.¹¹ A new “credit accord” that assigns to the Treasury the responsibility for all but very short-term lending to solvent institutions would have a number of advantages, I believe.

If systemic risks at large financial institutions are particularly protected by the safety net of government credit, then such institutions will have an extra incentive to acquire precisely those risks. This may be why the unexpectedly large exposures of large banking organizations to home-mortgage-related risks stemmed from their provision of backstop liquidity commitments to a wide array of off-balance-sheet securitization arrangements. Institutions that are viewed as too big to fail may have had a comparative advantage in supplying contingent liquidity that was most likely to be needed in the event of dire macroeconomic shocks because those are the circumstances most likely to elicit broad-scale government lending support.

In 1983, John Kareken of the University of Minnesota and the Minneapolis Fed described financial deregulation as “putting the cart before the horse,” suggesting that expanding the powers of banking and thrift institutions without appropriate attention to design of the financial safety net could be a risky move.⁶ His analysis was prescient, given the savings and loan debacle that followed later in that decade. Karaken’s emphasis was on deregulation in the presence of deposit insurance, but in the current episode, lending by the Fed and the Treasury has become just as important a part of the federal financial safety net.

In one popular view, credit market disturbances, such as the recent rise in losses on mortgage-backed securities, cause banks and other credit intermediaries to pull back credit supply as they attempt to repair their balance sheets... An alternative view is that shocks to the economy affect spending more directly, and that as growth declines, the creditworthiness of households and firms deteriorates, causing credit flows to fall and spreads to widen.

...my reading of recent events emphasizes the second view, in which the effect of slowing growth on credit conditions predominates. This view has received much less attention than it deserves, I believe, so let me say a few words about the current cycle in light of this issue.

Even though the conventional measure of the stance of monetary policy is the central bank’s interest rate target, monetary policy fundamentally is always about the amount of monetary liabilities issued by the central bank – also known as the “monetary base.” After all, hitting an interest rate target requires varying the quantity of central bank money, reducing the supply to raise rates and increasing the supply to reduce rates. Even when the policy rate has been driven down to zero, central banks can still dictate the supply of central bank money. And changes in the monetary base can still provide economic stimulus. Even if the funds rate does not change in response to an increase in the monetary base, some other rates of return must change to induce banks to voluntarily hold the additional supply of bank reserves.

Lacker, taking questions from reporters after a speech to the Charleston Metro Chamber of Commerce, said the tests "at this point" appear to be
sufficient.   "If conditions become worse than we expect them to get, we'll have to revisit those assumptions," he said. "As economic conditions evolve, the tests you might want to apply ought to evolve as well."
...
  Earlier Thursday, Lacker said the stress tests are crucial to easing the fear that has frozen financial markets.   "The stress test exercise is the most important part of it," he said, while speaking to students at the College of Charleston.

As reported by Dow Jones Newswires.

Third, market participants have at times faced uncertainty about prospective public sector intervention.³ The disparate responses to potential failures at several high-profile organizations last year may have made it difficult for market participants to forecast whether official support would be forthcoming for any given counterparty. Speculation this year about the structure of possible government rescue programs may also be contributing to financial market uncertainty.

"They're {Fed securities purchase programs} sized about right...given how I'm expecting the recession to play out over the course of the year," Lacker said following a speech.  "If things turned out differently, I could change my mind about the appropriate scale and trajectory of those programs," he said.

Some commentators have claimed that the housing boom and bust and the resulting turmoil illustrate fundamental flaws in modern financial markets and institutions. Before we jump to such conclusions, however, we need to evaluate the extent to which risk-taking incentives in financial markets have been distorted by actual and perceived government financial safety net protection. It strikes me as quite plausible that the major shortcomings of our system of housing finance are attributable primarily to the distorted behavior of institutions that are viewed as “too big to fail.”

Lacker said he was a big fan of the central bank's recent stress test. He said the report showed that the banking system is "well positioned" to make loans. He suggested banks are not lending because of a lack of credit worthy borrowers.

As reported by Market Watch.

Looking ahead, prognosticators this year have divided into several different camps. Some believe that high unemployment necessarily will lead to continually falling inflation for several years, and they are concerned about the risk of outright deflation. I personally have thought the risk of deflation was overstated, and for the first three months of this year, inflation has averaged 2 ¼ percent – both core prices and overall prices. Another camp places significant weight on the public’s expectations, and as near as we can figure, those are fairly well anchored around 2 percent. And finally, a third camp sees the rapid growth in our balance sheet, notes the historical association between rapid money growth and subsequent inflation, and wonders whether inflation will accelerate when the economy begins to recover.

Where do I stand? While I gravitate to the second camp – the one that views stable expectations as likely to anchor inflation in the near term – members of the third camp have identified inflation risks that are quite legitimate. The challenge for us on the Federal Open Market Committee will be to shrink our balance sheet and tighten policy soon enough when the recovery emerges to prevent rising inflation. The danger is that we will not shrink our balance sheet and tighten policy soon enough when the recovery emerges to prevent rising inflation. Choosing the right time to withdraw that stimulus will be a challenge, and I believe it will be very important to avoid the risks of waiting too long or moving too slowly.

The recently enacted fiscal stimulus program is aimed in part at boosting economic growth, but I believe many popular accounts overstate the effects of fiscal policy actions. Keep in mind that today’s stimulus will have to be paid for at some point in the future, and the prospect of higher taxes can restrain activity as well. Moreover, some spending diverts workers and firms from other uses instead of drawing in unemployed resources. My sense is that the stimulus is likely to have only a marginal effect on the broad contours of the economic recovery.

Most prominent forecasters expect the recession to end later this year, and I believe that is a reasonable view.
...
A set of improving indicators coming from the housing market provides further reason to believe the recession will end by year-end.

The lesson I take from all this is that the existence of our financial safety net actually can amplify financial instability. A discretionary safety net in particular, creates incentives for “too-big-to-fail” institutions to pay little attention to and underprice some of the biggest risks we face – risks associated with events like the current turmoil in which large losses are widespread. Their tendency to underprice such risk exposures reduces market participants’ incentive to prepare against and prevent the liquidity disruptions that are financial crises, thus increasing the likelihood of crises.

The various ways, both explicit and implicit, in which banks stood behind their off-balance sheet arrangements ultimately meant that the loans and other assets that ostensibly were moved off the balance sheet had the ability to come back onto banks’ balance sheets. You might say that they became “boomerang assets,” in the sense that they would have been expected to boomerang back to the banks when investors turned away from the obligations of off-balance sheet entities.

During a question-and-answer session after his speech, Lacker said the recent experience of stress testing of U.S. banks had provided clarity for the markets about their current position.

'I think the market reaction demonstrates the extent to which it's viewed as producing a much more reliable set of assessments about the relative health of financial institutions,' Lacker said.

Lacker said the stress tests would help provide private-equity investors with more confidence to invest in banks, since they would now be less fearful their investments would in the future be diluted as a result of the U.S. government having to increase its own stakes in the banks again.

'The reduction of uncertainty about future government dilution...has done more to facilitate the prospects for private-equity recapitalization of the banking system,' he said.

As reported by Dow Jones Newswires.

Looking back on the crisis thus far, however, I believe that a strong case can be made that the financial safety net, especially those parts that were more implicit and perceived than explicit and written into the laws, played a significant role in the accumulation of risks that ultimately led to the turmoil we are still experiencing. While deployment of the financial safety net is often viewed as an essential response to the financial crisis, I believe we need to give serious thought to the extent to which the safety net was actually a significant cause of the crisis.

Credit market conditions have eased generally, especially in commercial paper and interbank lending markets. While this is no doubt due in part to the broader moderation in economic conditions, I think it also stems partly from a decline in the underlying uncertainty about credit losses and the conditions of our larger banking organizations. The recently completed "stress test" for the 19 largest banks also contributed to the improvement in financial market conditions. While many of these banks still face significant losses, the stress test results dispelled some concerns about gloomier loss estimates and greater government ownership, and required banks to create plans to ensure that they have enough capital to absorb those losses. A number of banks appear to have made substantial progress already in bolstering their capital.

[A]fter many months I am finally able to say with a reasonable degree of confidence that the outlook is improving. We’ve endured the worst downturn that the economy has experienced in most of our lifetimes, and conditions remain distressed in many industries and localities. Yet the economy appears to have leveled out and I believe we can look forward to better times ahead.

…

The typical forecast calls for positive GDP growth in the current quarter and a gradual improvement beyond that. I agree with this outlook. Indeed, since the beginning of this year I have been expecting positive growth before year-end – but I must emphasize that the recovery is likely to be slow and uneven for some time.

From a technical point of view, I do not see a problem {with the Fed upholding its price stability mandate}– we do have the tools to contract our balance sheet and remove monetary stimulus when we need to do so, as Chairman Bernanke explained in detail in last month’s Monetary Policy Report to Congress. The harder problem is choosing when and how rapidly to remove stimulus as the recovery begins. I am certainly aware of the danger of aborting a weak, uneven recovery if we tighten too soon. But there can be a strong temptation to hesitate when emerging from a recession, awaiting conclusive signs of robust growth. Keeping inflation well-contained may require action before a vigorous recovery has had time to establish itself.

With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus that purchasing the full amount authorized under our agency mortgage-backed securities purchase program would provide.

For the record, the core price index for personal consumption expenditures increased 1.5 percent in the last 12 months. That’s right on target, as far as I’m concerned, and so a large further decline would be unwelcome.

The scale and scope of the financial safety net should be matched by the scale and scope of the regulatory and supervisory regime surrounding financial institutions. The central role of prudential regulation is to constrain and prevent the excessive risk-taking that would otherwise be induced by the incentive effects of safety net support.

The leading proposals before Congress concentrate almost exclusively on expanding government protection and regulation, but I believe we would be better off placing greater reliance on market-based incentives for prudent risk management.

The wider we cast the net, the greater the incentives of market participants to evade regulatory constraints while still availing themselves of protection in situations of distress, leading to a continuing cycle of crisis and bail out. And I have a hard time believing that we really need a publicly funded financial-institution support system covering nearly half of the liabilities in our credit markets.

I believe there is. And I think we've made a start on that with the announcement we made in March of agreement on several key principles. I'd like to see work pick up on that in the next couple of quarters if we could - in the next year.

We have an independent balance sheet. And that's essential to our ability to preserve price stability and to conduct monetary policy, because our liabilities are unique. They're monetary liabilities. And so our ability to calibrate and gauge the right quantity of those monetary liabilities, providing the economy, is essential today.

That means we have an independent balance sheet. But if we have an independent balance sheet as long as we do, we're going to be a target for those elements of the government that would like to lend without having to go to Congress, without having to put it on the stated balance sheet of the US government, the US Treasury, and without having to have it show through to the calculated - the reported budget numbers.

And that's especially acute temptation in a crisis. But that compromises our independence. It compromises potentially our ability to conduct monetary policy on an independent basis, and it's an end run around the constitutional safeguards, around the appropriations policy.

So I think it would be better government, better central bank policy, if we were to have an accord that said these emergency lending operations are the responsibility of the US Treasury.

But assuming stable inflation expectations, we're going to look for - I at least am going to look for growth to reestablish itself firmly enough that we're confident that real interest rates need to rise.  When that happens is open to - subject to a lot of uncertainty. It's impossible to predict in advance. We're going to look at a broad range of indicators, not look at any one data series in doing that. But that's generally the shape of things.

...

I don’t think that is a showstopper if the unemployment rate hasn’t starting falling yet {when we start to tighten}.   We have never done it. T here is a first time for everything.

I think in hindsight there's some things we would have done differently. The supervision we did, on the banks that we did supervise, I think we did very well, and I think it showed that those abuses, those subprime mortgage problems, didn't show up in the entities we were supervising and examining.

Where the problems arose were outside the banking system, in entities that we didn't have a right to go in and examine on a regular basis.

So I think - I'd give us pretty good marks for implementation. I think in hindsight there's things we would have done differently in rule making.

"We'll obviously be looking at the data as it comes in. Right now, I don't think it's time to raise interest rates."

As reported by Dow Jones Newswires.

I would prefer to see more emphasis on giving people the information they need in a clear and understandable format – especially targeted information that will help them to avoid making serious errors – rather than restricting their access to financial products.

Inflation has been running about 1.5 percent recently, and from my point of view, that's ideal. Earlier this year some economists were highlighting the risk that the low level of economic activity could push the rate of inflation down, perhaps even below zero. I think the risk of a substantial further reduction in inflation has diminished substantially since then. The historical record suggests that the early years of a recovery are when the risk is greatest that confidence in the stability of inflation erodes and we see an upward drift in inflation and inflation expectations. This risk could be particularly pertinent to the current recovery, given the massive and unprecedented expansion in bank reserves that has occurred, and the widespread market commentary expressing uncertainty over whether the Federal Reserve is willing and able to promptly reverse that expansion.

As a technical matter, I do not see any problem – we do have the tools to remove as much monetary stimulus as necessary to keep inflation low and stable. The harder problem is the same one that we face after every recession, which is choosing when and how rapidly to remove monetary stimulus. There is no doubt that we must be aware of the danger of aborting a weak, uneven recovery if we tighten too soon. But if we hope to keep inflation in check, we cannot be paralyzed by patches of lingering weakness, which could persist well into the recovery. In assessing when we will need to begin taking monetary stimulus out, I will be looking for the time at which economic growth is strong enough and well-enough established, even if it is not yet especially vigorous.

Inflation has been running about 1.5 percent recently, and from my point of view, that's ideal. Earlier this year some economists were highlighting the risk that the low level of economic activity could push the rate of inflation down, perhaps even below zero. I think the risk of a substantial further reduction in inflation has diminished substantially since then. In fact, we have seen that even in the early stage of a recovery, inflation and inflation expectations can drift higher. The perception of inflation risk could be particularly pertinent to the current recovery, given the massive and unprecedented expansion in bank reserves that has occurred, and the widespread market commentary expressing uncertainty over whether the Federal Reserve is willing and able to promptly reverse that expansion.

“When we get to the point where we feel like we need to reduce bank reserves, we will have a number of options to choose from,” he said to reporters.
“The natural place to start is asset sales,” he said.  “It is the one, to my mind, that we are the most sure that it would bring about a reduction in our monetary liabilities.”

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

One option you might want to consider is that our policy rate is the interest rate on excess reserves and we let the fed funds rate trade with some spread to that.

In a Q&A session with journalists, as reported by Bloomberg News

I have argued elsewhere that the most important step to ensuring long term financial stability is to establish clear and credible limits to the federal financial safety net – which has grown considerably as a result of the response to the crisis. I believe that the crisis itself was in no small measure the result of our not having clear limits on government support. Leverage and excessive risk-taking were encouraged by the belief that large parts of the financial system were implicitly protected, and those beliefs have been ratified. If we retain a stance of official ambiguity as to when such protection will or will not be forthcoming in the future, then I suspect our susceptibility to disruptive financial crises will continue to grow, and with each crisis, the safety net will become ever more expansive. A more expansive safety net will inevitably require more stringent regulation, but regulatory systems are necessarily limited in their capacity to completely offset the incentive distortions due to the safety net. So just like ambiguity about the path of future fiscal policies, continued ambiguity about the financial safety could limit our capacity for growth in the long run.

I have argued elsewhere that the most important step to ensuring long term financial stability is to establish clear and credible limits to the federal financial safety net – which has grown considerably as a result of the response to the crisis. I believe that the crisis itself was in no small measure the result of our not having clear limits on government support... If we retain a stance of official ambiguity as to when such protection will or will not be forthcoming in the future, then I suspect our susceptibility to disruptive financial crises will continue to grow, and with each crisis, the safety net will become ever more expansive. A more expansive safety net will inevitably require more stringent regulation, but regulatory systems are necessarily limited in their capacity to completely offset the incentive distortions due to the safety net. So just like ambiguity about the path of future fiscal policies, continued ambiguity about the financial safety net could limit our capacity for growth in the long run.

Some observers argue that the financial reform agenda should include changes in the role and governance of the Federal Reserve...   I know it might sound self serving for a Fed insider to object to such changes, but I believe such moves would present very serious risks to the effectiveness of monetary policy and ultimately to economic growth and stability...  The governance of the Federal Reserve System balances accountability, with ultimate authority resting in Washington, and independence, with the participation of non-political leaders from throughout the country.  While the performance of our economy in the last two years has clearly been unsatisfactory, and policy mistakes may have contributed to our problems, the Fed's balanced, hybrid governance structure has, I believe, given us a good record over the better part of three decades. Disrupting that balance would pose another long term challenge for our economy.

[R]egulatory improvements alone, as essential as they are, won't be enough. This cycle of crisis, rescue and by-pass is destined to recur, and with ever more force, unless we alter what market participants believe will happen when a financial firm becomes distressed. Recognizing that market discipline requires that creditors expect to bear losses on insolvent counterparties, many financial reform proposals create a new failure resolution process that gives policymakers additional "tools," besides the existing bankruptcy code, for handling failing firms.

The Federal Reserve's pledge to keep interest rates near-zero for an extended period remains "appropriate right now," said Jeffrey Lacker, the president of the Richmond Federal Reserve Bank on Monday. Going forward, the Fed will "continually" review whether the wording should be softened, he said. "When we take it out, when we start thinking about withdrawing monetary stimulus is obviously going to depend on how the news breaks over the next year or two."

I said a couple months ago I was comfortable with [the "extended period" language]. I'm still comfortable with it, but my comfort is diminishing somewhat over time. And it's something that I'm not be comfortable with forever. I think it's important to recognize that extended period is not a time period with a fixed number of months or a fixed number of meetings attached to it. And we're gonna have to choose policy as the data comes in.

STEVE LIESMAN: Some people think that 100 basis points discount rates over fed funds is normal. Is that right?

JEFFREY LACKER: Well, that's what we did when we- sort of configured the - the way to do back in 2002. And went to this- regime of- a normal spread above the target rate. But there's been some sentiment that it- it maybe ought to be 50- just to make it a more available, less costly- safety balance- for the banking system- in routine times. And I think the jury's out.

One of these is the path of future federal budget deficits implied by current and planned fiscal policies. The government's debt cannot grow indefinitely at a rate much faster than the economy itself grows, so ultimately, something has got to change — either taxes are raised, spending is reduced, or the real value of the debt is eroded through an increase in inflation, an outcome the Federal Reserve is committed to preventing. Failure to establish credible plans for bringing the fiscal position back into balance is likely to dampen economic growth, since growing government debt relative to GDP would ultimately compete with private borrowing by businesses and households.

'A couple of months ago, I was saying I was comfortable with the extended period language,' he told reporters after a speech.  'The recent data has made me think that it might be sooner rather than later that we would move that language. It depends on more data coming in,' he said.

As reported by Reuters

Last month, Fed officials reiterated a pledge to keep rates very low for an “extended period,” citing employers’ reluctance to add jobs and depressed home building.

“I think the recent data has made me think that it might be sooner rather than later that we remove that language” on the duration of low rates, Lacker said to reporters after the speech, without specifying the data. “I’m not there yet.”

As reported by Bloomberg

facility. Both would amount to issuing Federal Reserve Bank debt to absorb reserves. While these may be useful as contingency measures, my preference would be to rely primarily on sales of the agency debt and agency-guaranteed mortgage-backed securities that we have purchased over the course of the last year. Such an approach would move us more rapidly to a "Treasuries-only" portfolio, and thus more rapidly reduce the extent to which our asset holdings are distorting the allocation of credit. There is no reason why MBS sales at a steady, moderate, pre-announced pace (as with our purchase program) needs to be disruptive to the markets for those securities. In fact, by adding to the floating private sector supply, it should improve market liquidity, which reportedly has been hampered by our large-scale purchases.

Tag:  Delivery failures

 suspect that most of you have heard that the recession is over and I also suspect that few of you feel like the recession is over. The unemployment rate is still high nationally and still rising in West Virginia. Perhaps the best analogy is to taking a hard foul on the way to the basket; the recession (the way economists define it) is over when you hit the floor. But you don't feel like it's over until you get back up on your feet, and even then you may have some lingering bruises. Well, the consensus is that we hit the floor last summer and have been in the process of getting back on our feet ever since. That represents recovery, but the pain is still with many of us to be sure, and we are a long way from a full recovery.

While the bills that have been passed in the Senate Banking Committee and on the House floor express the desire to see losses imposed on failing firms' creditors, they provide the government with wide-ranging discretion to designate financial firms as "systemically important" and use public funds in their resolution. But the resulting ambiguity about rescue policy is likely to just perpetuate the forces that brought us "too big to fail" to begin with. Improved regulations will contain the risks that brought us the last crisis, but new risk-taking arrangements inevitably will arise that by-pass existing regulatory restraints. If authorities allow creditor losses at one failing firm, then creditors are likely to pull away from other similar firms, fearing that authorities will forgo supporting them as well. Authorities will feel compelled to resolve uncertainty about implicit safety net support by expanding implied commitments. Subsequent regulations will rein in the new arrangements, the danger of which will by then be fully appreciated. But this just sets the stage for another cycle of by-pass, crisis, rescue and regulation.

A discretionary safety net, with no set boundaries, only feeds this cycle by giving market participants reason to believe that new, complex arrangements ultimately will be protected. It requires an ever-growing reach of financial regulation, and undermines the market discipline that helps align financial risk-taking with broader societal interests.

[The pace of the US economic recovery will be] moderate right now [but will be] strong by next year.

[R]ecognizing the right time to begin normalizing our monetary policy settings is going to be hard, and reasonable people can differ about this. For my part, I will be looking for the time at which economic growth is strong enough and well-enough established to warrant raising our policy rate. It may make sense, however, to begin normalizing our balance sheet in advance of raising rates. Normalizing our balance sheet means reducing its size, but also returning to our traditional Treasury-only asset holdings.

Inflation, the best we can measure it, has been running between 1 and 2 percent since early last year. Although some recent readings have come in below that range, I believe inflation is unlikely to stay that low. In fact, the public apparently expects higher inflation in the future, which suggests that policymakers will need to be careful to avoid waiting too long to raise rates.

At its last meeting, the U.S. central bank reiterated its pledge to keep interest rates extraordinarily low for an extended period. Lacker said he was still "marginally comfortable" with that pledge.

I think [selling assets prior to raising rates is] a legitimate option... My preference for normalizing our balance sheet with more alacrity comes from wanting to reduce that distortion, to the extent that it exists, sooner rather than later.

Asked if such conditions were robust enough to allow the Fed to alter its repeated commitment to keep borrowing costs at exceptionally low levels for an "extended period," Lacker said: "Not now. Maybe soon."

"I'm comfortable with rates low where they are right now," he said. "I think we're entering a period when, every quarter, it's going to be a legitimate question as to whether to raise rates or not."

I'm comfortable with rates where they are now, but later this year I think it will be a legitimate question about whether we drop ... the 'extended period' language and think about raising rates.

This is Main Street; not Wall Street; not Capitol Hill... What I want to emphasize is that we, and our sister Federal Reserve Banks across the country, are the Fed's connection to Main Street and the American people.

For some of you that hail from around here, this may be fairly obvious. But for those of you who have traveled a ways to be with us today, some from as far as Washington, D.C., our day-to-day work on behalf of our region is sometimes lost in the heated rhetoric about "the Fed" in connection with the financial crisis and financial regulatory reform.

“It would take a very substantial, unanticipated adverse shock” for further steps at stimulus to be appropriate, Lacker told reporters today in Richmond. “Consideration of further easing steps is very far away.”

"If inflation expectations don’t fall significantly, I don’t see how deflation is a big risk,” Lacker told reporters yesterday after a speech in Norfolk, Virginia. “The stability of inflation expectations is going to exert a gravitational pull."

[I]nflation is now on target, as far as I'm concerned. Over the last 12 months the price index for personal consumption expenditure has risen 1.5 percent, which is exactly what I've been recommending for the last six years. We also track a core price index that omits volatile food and energy prices, and it is sending the same message, having risen by 1.4 percent over the last 12 months. I believe that the Fed's best contribution to our nation's economic prosperity over time would be to keep inflation stable near the current 1.5 percent rate. But inflation has been lower this year, with overall inflation increasing at only a 0.7 percent annual rate, which is too low for me. I would point out that these inflation numbers often run hot or cold for several months at a time, which is why economists focus on the 12-month number I cited a moment ago. I am not yet convinced that inflation is likely to remain undesirably low. Moreover, the public's expectation of future inflation is not at such a low level; indeed, the latest survey from the University of Michigan puts the public's short-run inflation expectation at 2.2 percent. So I do not see a material risk of deflation — that is, an outright decline in the price level.

But risks remain, especially those associated with inadvertently creating false expectations that the Fed is preoccupied with achieving a specific level of the unemployment rate. Our ability to manage those risks will depend on when and how we choose to tighten policy, as eventually we must. To wait until unemployment reaches some predetermined level, as the Martin FOMC did in the 1960s, is likely to mean waiting too long. That strategy proved bitterly disappointing for Martin and his colleagues, and I expect it would prove disappointing for us as well. At some point in the not-too-distant future, we are likely to face an economy growing in a self-sustaining way while the unemployment rate is still relatively high by historical standards. The decisions we make at that time will be the true test of whether we've learned our lessons.

[T]he Committee noted that progress toward lower employment has been "disappointingly slow." That observation makes the important distinction that it is not the high level of unemployment alone that motivated the action, but rather the slow pace of improvement and the belief that further monetary stimulus could help.

There’s a little bit of hysteria out there [among critics of Fed policy].

[I]f growth picks up next year, as I and many other FOMC participants expect, the precautionary demand for liquidity by households, firms and banks will diminish. At some point we will need to respond by reducing the provision of liquidity to the banking system to prevent inflation from accelerating, as it often can when a recovery picks up steam. Further balance sheet expansion now could require more rapid balance sheet reduction later on, complicating the withdrawal of monetary stimulus when it becomes necessary to maintain price stability. It is appropriate, therefore, that the FOMC has committed to "regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed."

The price index for personal consumption expenditures has risen 1.3 percent over the last 12 months, which is very close to my own long-run objective of 1½ percent.

While the outlook may not have improved enough yet to warrant adjusting our purchase plans in the near-term, I anticipate earnest re-evaluation as economic developments unfold in the months ahead.

While the outlook may not have improved enough yet to warrant adjusting our purchase plans in the near-term, I anticipate earnest re-evaluation as economic developments unfold in the months ahead.

The downward trend in inflation during the recession had many commentators warning of the possibility of outright deflation. At this point, I think the risk of deflation is negligible.

I expect noticeably stronger growth in overall activity this year than last. If I had to write down a forecast today, it would be pretty close to 4 percent. A rate of growth in that neighborhood would result in continued net gains in employment and further reduction in the unemployment rate.

The Committee recognized that the provision of further monetary stimulus at this point in the business cycle is not without risks, and therefore committed to regularly review the pace and overall size of the asset-purchase program in light of incoming information and adjust the program as needed. The distinct improvement in the economic outlook since the program was initiated suggests taking that re-evaluation quite seriously. That re-evaluation will be challenging, because inflation is capable of accelerating, even if the level of economic activity has not yet returned to pre-recession trend.

I'm pretty confident we have the mechanism under command on our command. I think we know what to do. We know how to do it.

The timing and the pace are the key swing variables. Those are the things that are just really hard to get. When back - when we were just operating with interest rates, you saw the last expansion. We raised rates at a very steady rate and a very gradual rate. Back in '94, we raised rates a little more herky-jerky - big moves, pause for a while, big moves. We got a greater increase -- so getting the timing right when you start raising rates or start withdrawing monetary stimulus, and then getting the pace right, those two things are both very important.

On whether the timing or the mechanism of the exit strategy is a greater challenge

The debate ought to be who is in the safety net and who is out, being clear about who is in, regulating them appropriately. And then letting the rest deal with risk on their own. I think the markets are capable of doing that. And I think that requires a clear commitment for us to stay out of the process of bailing out large institutions that are outside the safety net.

The improvement in the growth outlook has been noticeable enough to tilt the case further against QE2... To my mind, it was a close call to begin with.

As long as inflation expectations are managed pretty well, I think we’re going to get through this [period of elevated oil prices] without a big burst of inflation.

I don't think it's going to derail the recovery.  Luckily we have a lot of experience and a lot of track record and a lot of data to process on this, because we've been through this before, seeing oil-price spikes. So in the first instance, it's going to pass through to consumer prices. That'll take a little chunk out of real personal income. So far this seems quite manageable.

The real danger is inflationary psychology. In the last couple of decades, these haven't tended to pass through to core beyond just a little bit of a blip in a couple of months. And so I think as long as inflation expectations are managed pretty well, I think we're going to get through this without a big burst of inflation.

In response to a question about the impact of higher oil prices.

Well, as I've been saying, inflation in the mid -- between 1 and 2 seems fine to me; seems pretty close to price stability. There were those who were worried about inflation when it got down for several months below 1, and that was a legitimate concern. I think we've seen the bottom of core inflation. I think it's going to stabilize or head up from here.

MR. LIESMAN: Does it really matter that much if you stopped it in March or let it run through to June? Is that period of time a consequential period of time? Are the amount of bonds that could be purchased consequential?

MR. LACKER: Well, I think every $100 billion counts. You know, we're talking about where the starting line is likely to be for the process of unwinding monetary stimulus at some point when the time comes. And, you know, I don't want to move the starting line too far back.

MR. LIESMAN: Can you walk me through how you foresee the Fed withdrawing stimulus? Is it reducing the size of the portfolio first and raising interest rates? Are they together? Are they separate?
What's the process by which you would prefer?

MR. LACKER: So I think we'd have more -- personally, my sense is that there's pluses and minuses on either side. One of the advantages of reducing the asset purchase -- unwinding the asset purchases first is that I think we'd have a better handle on the effect of increasing interest rates through increasing the interest we pay on reserves.  We'd have a better handle on how that's going to affect other rates if the size of bank reserves was smaller.

As I have said, [stress tests] have proven their usefulness in the crisis. Quantifying the risks at large financial institutions is a complex and costly process that is vulnerable to manipulation. A disciplined and well-organized supervisory process for validating those assessments strikes me as well worth the costs. Stress tests are not a panacea, however. In a sense they are only as good as the imagination of the scenario designers, who need to resist the temptation to dismiss extreme scenarios as too far-fetched or focus too much attention on preparing for the last war.

WSJ:  How will you judge when it will be the right time to begin tightening policy?

LACKER: Tough, tough question. It is really hard to write down a recipe or a check list about this. The growth rate matters, more than the overall magnitude of slack in the economy. I would again emphasize that we need to be sure we act before inflation expectations shift. We need to act in a way to prevent inflation expectations from shifting.

See Chairman Bernanke's comments on the same topic earlier in the week.

[Despite provisions in the Dodd-Frank bill,] the FDIC retains considerable discretion in the use of funds to limit losses to some creditors, and the Treasury can invoke orderly resolution for firms that have not been subject to enhanced regulation. The Fed also retains some discretionary power to lend to non-bank entities. This creates continued uncertainty about possible rescues, as well as gaps in our ability to provide clear, credible constraints on the safety net.

I don’t think tinkering with the timing [of the end of the current LSAP campaign] is nearly as important as the amount.

I haven’t made up my own mind yet [on the appropriateness of a reduction in our asset purchases]. I think it is worth reexamining. The flow of data since December has kind of made it even more worth reexamining.

“It wouldn’t surprise me if we need to act before the end of the year,” Lacker said today in a CNBC television interview. “Inflation is the bigger risk this year. That is what you have to keep your eye on.”

Lacker said tightening policy could include deciding not to reinvest proceeds from maturing mortgage-backed securities, selling assets and raising the Fed’s target interest rate from near zero. He said both asset sales and interest rate hikes “could be warranted this year.”

“The exact sequence of that is something we are hashing out and trying to think through,” Lacker said in the televised interview, adding “I haven’t made up my mind yet” on whether the Fed should reduce its plan to purchase $600 billion in U.S. Treasuries through June.

“I think it deserves very careful reconsideration,” he said.

As reported by Bloomberg News

“My personal predilection would be to get out of the MBS market as soon as possible,” Lacker said to reporters. “I think the housing finance market can easily withstand a substantial liquidation of our MBS holdings.”

I think rate hikes by year-end are certainly a possible outcome at this point given what we see in the momentum in economic growth and given how the inflation risks seem to have evolved.

With hindsight, I think it is fair to say that policymakers [in the last cycle] overestimated the extent to which high unemployment would keep inflation from accelerating, and as a result, waited too long to withdraw monetary stimulus. Four years of 3 percent inflation may not have been the worst of all possible outcomes, but I do not consider it a success. I hope we do better this time. In particular, I believe we need to heed the lesson of the last recovery that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend.

Consumer spending growth is likely to be somewhat restrained for a time as households adjust to these higher [energy] prices. I would be concerned if I expected further price increases. But at this juncture, futures markets are pricing in modest declines in petroleum products. If the markets are right, the effect of energy prices on consumer spending should only be temporary.

Barring significant unexpected developments, this should be the high-water mark for monetary stimulus in this cycle, with the focus going forward on the timing and pace of stimulus withdrawal. While timing and pace will depend upon how the economy behaves, I believe it will be important to remember the lesson of the last recovery – namely, that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend. To prevent that, it may be necessary to initiate policy tightening well before the unemployment rate has fallen to a rate we would expect to see over the long run.

Speaking to reporters after the speech, Lacker declined to outline a timeline for the withdrawal of stimulus, saying it depends on how the economy unfolds.

“This is the point in the business cycle when the risk of losing a bit of credibility and risk of losing ground on inflation is highest,” he said. It’s “far better to act preemptively than get behind the curve on inflation and have to catch up,” he said.

“The last batch of data is disappointing and it is causing us to rethink our outlook for growth for the remainder of the year,” Lacker said to reporters after a speech today in Roanoke, Virginia. “We could be stuck below trend for some time,” he said.

...

Lacker, who votes on monetary policy next year, said he plans to revise his forecast for 2011 growth to below the 3.5 percent to 4 percent he expected in January. He declined to give a new forecast.

“I still think growth will pick up later in the year,” Lacker said. “The longer growth goes on at this disappointing pace, the more seriously you have to take the notion we are in for a period of growth at trend rate rather than above trend.”

A third round of asset purchases, or so-called quantitative easing, wouldn’t address the reason for the sluggishness, Lacker said.

Setting a formal inflation target would be appropriate to address concern over rising prices, Lacker said. While he has advocated an inflation target of 1.5 percent, he said he would back a Fed consensus that set the goal at 2 percent.

“I think now -- this point in the business cycle -- would be a relative good time” and “relatively useful to clarify what we mean by price stability,” Lacker said at a conference on manufacturing in the Southeast U.S. hosted by Virginia Governor Bob McDonnell.

"If inflation risks materialize, I think we would need to respond by initiating exit even if growth remained disappointing," Lacker told reporters following a speech. Lacker said the consensus is for the economy to rebound in the second half of the year and for inflation to trend down to around 2%. Lacker said he was pretty comfortable with the inflation outlook now but that there was an upside risk to the inflation outlook. "There is going to be a risk of a step-up in inflation trends. We have seen that over the last nine months. Whether that is finished playing out or not, we don't have the data yet," he said. "I am hoping and expecting inflation to stabilize at around a 2% trend but there is the risk that it would continue to accelerate," he said. Lacker said he was comfortable with the current stance of policy but added that "I think we are going to have to watch carefully."

Many have read the FOMC statement as virtually guaranteeing that the Fed will hold the funds rate near zero for at least another two years, but Lacker said that is not a valid interpretation. “I would note that it’s a fairly mild statement in the sense that it’s highly contingent,” he said... “I think that if the economic data come in differently than the Committee expected then I think that will provide the opportunity to alter the terms of that statement.” 

 “That statement isn’t so much a commitment as it is a forecast,” he added.

...

Lacker said his main objection to the extended zero rate policy is directed elsewhere: “For me predominantly, it’s a matter of money creation and inflation.”

 “We operate monetary policy by moving short-term interest rates around over the business cycle,” he explained. “We do that because what’s required to get the money supply right, to keep inflation low and stable, a lower interest rate is required when the economy is soft, and a higher interest rate is required when the economy is strong.” “If we get the interest rate wrong we’re going to get the money supply wrong, and that’s going to get inflation wrong,” he continued. “And that’s why we vary interest rates with economic conditions the way we do. People confuse that with providing stimulus and working to offset shocks to growth, positive or negative.” 

 “So for me the chief risk is that it creates the ingredients for an acceleration of inflation.”

Various objections have been raised to a two-year quasi-commitment to holding the funds rate so low {including} that it would benefit large borrowers at the expense of savers…

Lacker acknowledged those potential costs, but indicated those are not his primary concerns. The trade-off between savers and borrowers is “always part of the mix when we change policy and change the interest rate trajectory,” he said.’

“My sense of Operation Twist is if it has economic effects, it is more likely to raise inflation that it is to measurably raise growth,” Lacker told reporters after his speech. “I would not have supported it.”

“There are impediments to growth that somewhat lower longer-term interest rates would not be the antidote for,” Lacker said of the policy, known as Operation Twist. “Our role is fairly limited in terms of increasing growth.”

The factors likely to be restraining growth — from empty houses to prospective tax rates — are nonmonetary and largely beyond the power of the central bank to offset through easier monetary conditions. History has repeatedly demonstrated that if a central bank attempts to add monetary stimulus to offset nonmonetary disturbances to growth, the result is higher inflation that can be difficult and costly to eliminate. This is why I opposed the Maturity Extension Program — popularly known as "Operation Twist" — in which the Fed will buy long-term Treasury securities and simultaneously sell short-term Treasury securities. The effect of these operations is uncertain, but likely to be relatively small. My sense is that the main effect will be to raise inflation somewhat rather than increase growth.

The financial crisis of 2007 and 2008 was a watershed event for the Federal Reserve and other central banks. The extraordinary actions they took have been described, alternatively, as a natural extension of monetary policy to extreme circumstances, or as a problematic exercise in credit allocation. I have expressed my view elsewhere that much of the Fed's response to the crisis falls in the latter category rather than the former.

...

Like the Fed, the European Central Bank and other central banks have pursued credit allocation in response to the crisis.

The impulse to reallocate credit certainly reflects an earnest desire to fix perceived credit market problems that seem within the central bank's power to fix. My sense is that Federal Reserve credit policy was motivated by a sincere belief that central banks have a civic duty to alleviate significant ex post inefficiencies in credit markets. But credit allocation can redirect resources from taxpayers to financial market investors and, over time, can expand moral hazard and distort the allocation of capital. This implies a difficult and contentious cost-benefit calculation. But no matter how the net benefits are assessed, central bank intervention in credit markets will have distributional consequences.

... 

This tension is a classic time consistency problem. Central bank rescues serve the short-term goal of protecting investors from the pain of unanticipated credit market losses, but dilute market discipline and distort future risk-taking incentives. Over time, small "one-off" interventions set precedents that encourage greater risk taking and increase the odds of future distress. Policymakers then feel boxed in and obligated to intervene in ever larger ways, perpetuating a vicious cycle of government safety net expansion.

The conundrum facing central banks, then, is that the balance sheet independence that proved crucial in the fight to tame inflation is itself a handicap in the pursuit of financial market stability. The latitude the typical central bank has to intervene in credit markets weakens its ability to discourage expectations of future rescues and thereby enhance market discipline.

“Greater transparency should be achievable for us,” Lacker said in response to a question about the Fed’s internal deliberations on communication policy. “For a long time I have advocated an explicit numerical inflation objective.”

Inflation is terribly important as a central bank goal and I think we owe the public a commitment to an announced objective for inflation.

"Our progress against the maximum employment component of our mandate needs to be evaluated, with a realistic sense of what employment is actually achievable now," Lacker said. "I don't think it makes sense to hold us accountable for the employment that might have been achieved, had none of the shocks of the last 10 years occurred."

At the recent meeting that concluded on January 25, this guidance stated that the Committee currently anticipates that 'economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.'

"I dissented because I do not believe economic conditions are likely to warrant an exceptionally low federal funds rate for so long. I expect that as economic expansion continues, even if only at a moderate pace, the federal funds rate will need to rise in order to prevent the emergence of inflationary pressures. This increase in interest rates is likely to be necessary before late 2014.

"In addition, the Summary of Economic Projections (SEP) now contains detailed information on the forecasts of Federal Reserve governors and Reserve Bank presidents for the evolution of economic conditions and the federal funds rate under appropriate policy. My dissent also reflected the view that statements about the future path of interest rates are inherently forecasts and are therefore better addressed in the SEP than in the Committee's policy statement.

“The labor market is facing some serious impediments,” Lacker said. “They are real in nature and not monetary. I haven’t been convinced that more monetary stimulus would help the labor market improve materially more rapidly.”

Unemployment “could well be above 7 percent, and I think we have to prepare for that,” Lacker said. “I think it’s a misconception to think we have to get unemployment all the way down to five or some number like that before we raise rates.”

It’s important to recognize that our forward guidance language is a forecast of how monetary policy will turn out, not an unconditional promise. Future monetary policy decisions will depend on future economic data — and the future economic outlook. As new data arrive, the outlook for future economic conditions will change, and the outlook for the future of monetary policy should change as well.

I dissented in January because I did not believe that economic conditions are likely to warrant low interest rates all the way through 2014. (I was not a voting member last year.) My projection is that if we want to keep inflation at 2 percent, we will likely need to raise rates in 2013. Incoming data could change my assessment in either direction.

One broad quantitative measure of mismatch comes from what's called "the Beveridge curve," which refers to the relationship between unemployment and vacancies. Since the recession ended, that curve has departed from its prerecession position. Typically when the number of vacancies is low, unemployment is high, since workers are competing for a limited number of open positions. Conversely, when vacancies tend to be high, unemployment tends to be low. At present, however, both the unemployment and vacancy rates are relatively high, which suggests that unemployed workers are not finding jobs as rapidly as usual, despite the large number of open positions. This apparent outward shift in the Beveridge curve suggests that labor markets have become less effective at matching workers and vacancies. Empirical estimates suggest that this reduced efficiency could account for between 1/2; and 1-1/2 percentage points of unemployment.

Some commentators are urging the Fed to take additional action as long as the unemployment rate remains elevated. But if elevated unemployment reflects largely fundamental factors rather than insufficient spending, such stimulus might have little impact on unemployment and instead just raise the risk of pushing inflation up.

It is the magnitude of sectoral shifts that is impeding the effectiveness of our ability to find matches for unemployed workers.

"There's some sentiment around that table for doing more. Personally, my sense is that monetary policy isn't capable of having a material effect on growth, or employment, or unemployment at this point."

“I’m in the camp of being a bit of a skeptic about more monetary stimulus at this time.”

The effects [of the latest round of asset purchases] are very hard to gauge, but my sense is that this is going to have a greater effect on inflation and a minimal impact on jobs

The Committee’s statement also altered the “forward guidance” regarding future monetary policy, stating for the first time that it expected a highly accommodative stance of monetary policy for “a considerable period after the economic recovery strengthens.” I disagreed with this statement because I believe a commitment to provide stimulus beyond the point at which the recovery strengthens and growth increases implies too great a willingness to tolerate higher inflation and would be inconsistent with a balanced approach to the FOMC’s price stability and maximum employment mandates.

Finally, I strongly opposed purchasing additional agency mortgage-backed securities. These purchases are intended to reduce borrowing rates for conforming home mortgages. Such purchases, as compared to purchases of an equivalent amount of U.S. Treasury securities, distort investment allocations and raise interest rates for other borrowers. Channeling the flow of credit to particular economic sectors is an inappropriate role for the Federal Reserve. Central banks abuse their independence when they promote some borrowers at the expense of others. This principle was recognized in the Joint Statement of the Department of Treasury and the Federal Reserve on March 23, 2009: “Government decisions to influence the allocation of credit are the province of the fiscal authorities,” that is, Congress and the administration.

In evaluating the current stance of monetary policy, the long-run unemployment rate would appear to be an attractive yardstick, since it provides a sense of where one ultimately would like to be. But for assessing monetary policy on a month-to-month or quarter-to-quarter basis, the long-run unemployment rate can be very misleading. For example, when unemployment is relatively high, it’s unlikely that unemployment can be made to return to the long-run unemployment rate at a very rapid clip — within a quarter or two, say. At such times, the best possible monetary policy will only bring unemployment down gradually over time.  We can debate whether a given pace is faster or slower than optimal. But there is undoubtedly some optimal pace, and it’s unlikely to be virtually instantaneous. While that convergence process is going on, to what unemployment rate should we refer when assessing monetary policy? In other words, while an economy is adjusting to significant economic shocks, what constitutes “maximum employment”? Surely not the long-run rate, because how far we are away from that rate does not, in general, tell us how fast we should be returning...

There is a clear intuition for having the unemployment yardstick for monetary policy vary with economic conditions...From this perspective, some popular empirical practices are of dubious value for evaluating current monetary policy. For example, estimates of an older concept known as the “non-accelerating inflation rate of unemployment,” or “NAIRU,” are aimed at measuring the long-run normal unemployment rate. Estimates of NAIRU invariably impose the assumption that it varies only slowly and does not respond to many transitory shocks...

The collapse in housing construction was a huge blow to our economy, and it will take a substantial amount of time for us to recover by shifting labor, capital and spending toward other growth opportunities. Thus, my assessment is that a reasonably strong case can be made that the natural rate of unemployment that corresponds to the Fed’s maximum employment mandate is now relatively elevated.

If we are going to purchase more assets, it would be better to purchase Treasury securities rather than agency mortgage-backed securities. Buying MBS rather than Treasuries may reduce borrowing rates for conforming home mortgages, but if so, it will raise interest rates for other borrowers and thus distort credit flows. This is an inappropriate role for the Fed.

It’s important for us to remember that we cannot continually buy more securities and create more bank reserves without jeopardizing our inflation goal. Accordingly, I have opposed additional easing steps at FOMC meetings this year. My main concern is that we have eased policy aggressively for over four years; at some point, the growth outlook will improve enough that the FOMC will need to begin raising interest rates and reducing the supply of bank reserves in order to preserve the price stability that we have enjoyed over the last 20 years. The larger our balance sheet when the time comes to withdraw monetary stimulus, the more difficult and risky that process will be. In my view, the balance of considerations suggests that we should be standing pat now rather than easing policy further.

"It should be pretty clear that this committee is straining to provide as much stimulus as possible without endangering our price-stability credibility,” Lacker told CNBC in an interview. “My worry, and the reason I dissented on this and the asset purchases, is that we seem to be willing to test the very limits of that credibility."

In my view, the supply of bank reserves is already large enough to support the economic recovery, and the benefits of further asset purchases are unlikely to be sizeable. The effects on longer-term interest rates are uncertain and likely quite small, and the potential to boost job creation seems quite limited, given the fundamental impediments that appear to be restraining growth now. At the same time, it’s important to recognize the potential costs of additional asset purchases. A larger Fed balance sheet will increase the risks associated with the timely and appropriate withdrawing of monetary stimulus by raising interest rates and selling assets.

My assessment was that the costs associated with additional asset purchases outweighed the expected benefits, and thus, I dissented.

I dissented from these Committee actions and have expressed my concerns at length elsewhere. Briefly, as I’ve touched on today, I think that further monetary stimulus is unlikely to materially increase the pace of economic expansion, and that these actions will test the limits of our credibility. At some point, we will need to withdraw stimulus by raising interest rates and reducing the size of our balance sheet, and the larger our balance sheet, the more vulnerable we will be to seemingly minor miscalibrations in policy. Accordingly, I see an increased risk, given the course the Committee has set, that inflation pressures emerge and are not thwarted in a timely way.

We’re at the limits of our understanding of how monetary policy affects the economy… Sometimes when you test the limits you find out where the limits are by breaking through and going too far.

“I do not expect inflation to rise significantly in the next year or two,” Lacker said. “But I will say that given the policies we have adopted, I see upside risks.”

“There’s still work to do,” Evans said today in a speech in Richmond, Virginia. “The committee currently thinks that at the end of 2014 we’re still going to be below the inflation objective and unemployment is still going to be above 5.5 percent” he said, referring to the central bank’s dual mandate for stable prices and maximum employment.

“In about two years, we are still going to be missing.”

The living wills program will require a great deal of hard work and detailed analysis. But I see no other way to reliably identify exactly what changes are needed in the structure and operations of financial institutions to end "too big to fail." I see no other way to achieve a situation in which policymakers consistently prefer unassisted bankruptcy to incentive-corroding intervention and investors are convinced that unassisted bankruptcy is the norm.

"I wouldn't have gone down this asset-purchase path. I'm in the camp that we should taper and stop right now," Lacker said in a "Squawk Box" interview from the 2013 Credit Markets Symposium in Charlotte, N.C. "You have to prepare markets, if it was up to me, if you made me dictator, that's what I would do."

Growth has resumed, however, and it appears as if it’s limited, in large part, by structural factors that monetary policy is not capable of offsetting. In this situation, the benefit-cost trade-off associated with further monetary stimulus does not look promising. The Fed seems to be unable to improve real growth, despite striving mightily over the last few years, and further increases in the size of our balance sheet raise the risks associated with the “exit process” when it’s time to withdraw stimulus. This is why I do not support the current asset purchase program.

“This asset-purchase tapering is just slowing the rate at which we’re increasing the balance sheet,” Lacker, who doesn’t vote on the Federal Open Market Committee this year, said today in a Bloomberg Television interview with Peter Cook. “We’re not anywhere near decreasing the balance sheet yet.”

There appears to be widespread confidence that the Federal Reserve will keep inflation low and stable, consistent with our announced inflation goal of 2 percent. Indeed, most forecasters view the current readings on inflation to be a temporary phenomenon and expect inflation to run at or a little below 2 percent over the next few years. Household surveys and financial market measures also indicate that inflation is expected to remain near its longer-term average. My own view is that the transitory factors depressing inflation are likely to ebb, and we’ll see inflation edge back toward the Federal Open Market Committee’s target of 2 percent by next year.

... Looking ahead, the key question regarding the economic outlook is whether growth will remain relatively low. Many forecasters expect growth to pick up to over 3 percent next year. I have become increasingly persuaded, however, that low growth rates are likely to persist for several years.

...the slow growth in real GDP in this expansion is related to both lower productivity growth and lower employment growth. While economists understand the principles underlying productivity growth, it’s quite difficult to parse the causes of medium-term swings in productivity growth, particularly as they are happening. At this juncture, low productivity growth has persisted long enough that I think the best guess is that it will remain low for an extended period.

I did, however, think it wise of Chairman Bernanke to clarify the Committee’s expectations regarding how the pace of asset purchases is likely to evolve. Bond and stock markets fell sharply in response, but that should not be too surprising. The Chairman’s statement forced financial market participants to re-evaluate the likely total amount of securities the Fed would buy under this open-ended purchase plan — in other words, how much liquor would ultimately be poured into the punch bowl. Market participants also had to reconsider their estimate of when the Federal Reserve would begin to remove the punch bowl by raising interest rates. These reassessments appear to have warranted price changes across an array of financial assets. As market participants gain additional insight from the words of Federal Reserve officials or by policy actions in coming quarters, further asset price volatility seems likely.

“We’re entering a period now where risks are going to be more two-sided about policy, and I think that’s naturally going to be a period where fixed-income markets are going to be more volatile,” Lacker told reporters. “When tightening becomes closer in time, you’re going to get more fixed-income volatility.”

The FOMC’s September meeting, the next to be accompanied by a press conference by Bernanke, is “certainly a candidate” for when the Fed “could first reduce the pace” of its asset purchases, Lacker told reporters. He repeated that any decision “is going to depend on the data” about the economy.

As reported by Bloomberg News

"We must make our exit from the bond-buying programme quick," Richmond Fed President Jeffrey Lacker, one of the Fed's most fiscally conservative officials and a persistent critic of the latest round of bond buying, said in WirtschaftsWoche.

"An end to these bond purchases came into sight at the latest Fed meeting," said Lacker.

…

"First of all we should end the monthly purchases of mortgage bonds as quickly as possible," Lacker said in the interview. It was not the central bank's role to give any sector preferential support, he said.

Lacker said the United States had made hardly any progress in cutting its debt and had instead only come up with temporary solutions for several months at a time. He said he hoped the Fed's planned scaling back of bond purchases this year and rising interest rates would force the U.S. Congress to agree more quickly on reducing debt. "We need a sustainable solution and the sooner the better," he said.

As reported by Reuters.

These lending operations changed the composition of the Fed's asset portfolio without changing the Fed's monetary liabilities, and thus constituted "credit policy," not monetary policy.4 Such lending raises important issues related to the independence of central banks and their role in the financial system.5 I have spoken at length about these issues on other occasions, but they are not my focus today.6

…

When a central bank uses its independent balance sheet to choose among private sector assets, it invites special pleading from interest groups and risks entanglement in distributional politics. Similar political risks face a central bank, such as the European Central Bank, allocating investments across multiple sovereign debt issuers.

Political pressure to channel credit to favored sectors is not without precedent in the United States. Congress gave the Fed authority to buy the debt of U.S. agencies such as the housing government-sponsored enterprises in 1966 in response to the "credit crunch" that year that reduced flows to housing finance… In 1971, the FOMC relented and began outright purchases of the debt of the housing government-sponsored enterprises.12 (By 1981, purchases had stopped, and the Fed's holdings ran off gradually over the 1980s and 1990s. Outright purchases of agency securities were not conducted again until early 2009.)

How central banks manage the political risks associated with forays into credit policy may prove pivotal for the evolution of central banking in advanced economies. A central bank's core responsibility revolves around its liabilities — that is, the monetary assets it uniquely supplies. Being organized as distinct, off-budget intermediaries, however, requires them to hold assets, and just what assets the central bank should hold has been something of a conundrum…

Of the risks associated with unconventional monetary policies, those associated with central bank holdings of unconventional asset classes may be the most consequential. Violating the implied truce under which central banks avoid credit policy has the capacity to perturb the delicate governance equilibrium supporting the independent conduct of monetary policy. History provides numerous examples of compromised central bank independence leading to calamitous monetary policy.

Credibility requires consistency, over time, between a central bank's statements and its actual subsequent actions. A central bank's statements will have greater immediate effect on the public's expectations the more they are seen as limiting the central bank's future choices. Yet there are likely to be circumstances, ex post, in which the central bank feels constrained by past statements. Yielding to the temptation to implicitly renege by reworking decision criteria or citing unforeseen economic developments may have short-term appeal, but widely perceived discrepancies between actual and foreshadowed behavior will inevitably erode the faith people place in future central bank statements. So central banks face an ex ante trade-off, as well, between the short-run value of exercising discretion and the ability to communicate effectively and credibly in the future.

To sum up, then, the most critical economic decisions people face over their lifetime concern investments in their human capital. Financial education has traditionally promoted college enrollment by providing prospective students with information on financing options. But success in college is by no means automatic, and the benefits of attending — but not completing — college are relatively low. I have advocated that financial educators shift toward informing students about the value of college preparedness and the value of alternatives to a traditional four-year college degree, such as community colleges and vocational and apprenticeship programs. In addition, making sure students are well aware of the magnitude of the return to successful college completion would reduce the odds of well-qualified students forgoing college attendance. And finally, I was unable to resist the opportunity to put in a plug for early childhood intervention, where research has demonstrated the value of targeted, high-quality programs.

Resolution planning will require a great deal of hard work. But I see no other way to ensure that policymakers have confidence in unassisted bankruptcy and that investors are convinced that unassisted bankruptcy is the norm, both of which strike me as necessary to solving the "too big to fail" problem. Resolution planning provides a framework for identifying the actions we need to take now to ensure that the next financial crisis is handled appropriately, in a way that is fair to taxpayers and establishes the right incentives.

The Fed was envisioned as operating within and facilitating adherence to the gold standard. While price stability was an important goal of the founders of the Fed, one to which they expected the Fed to contribute, their focus in founding the Fed was something else entirely. It was to solve "the currency problem." This is an unfamiliar term to modern ears, so it deserves a bit of explanation. Before the founding of the Fed, paper currency was supplied by national banks, but was subject to a collateral requirement that dated back to the Civil War; banks' note issues had to be backed by holdings of U.S. government bonds. The aggregate supply of notes was widely described as "inelastic," because expanding a bank's note issue was often costly and cumbersome. At times, the public demand for notes rose as the public sought to convert bank deposits into paper currency or gold. This typically occurred during the autumn harvest season and the holiday shopping season, as well as during so-called banking panics, when bank customers sought to pull deposits out of banks.

The inelasticity of the physical supply of bank notes meant that other adjustments had to take place instead...

Thus the preamble of the Federal Reserve Act lists as one of its purposes "to furnish an elastic currency." The ultimate objective can be thought of as keeping the defective legislative framework around U.S. banking from damaging domestic and international markets.

“I have been surprised by the stability of inflation and inflation expectations.”

“Given the expansion of our balance sheet, if you told me we were heading to a $4 trillion balance sheet, $4 trillion of outside money in the system, and that inflation expectations have remained stable, and apparently as a result inflation itself has remained remarkably stable, I wouldn’t have put 99% probability on that. I would have put much less probability on that,” Mr. Lacker said in response to audience questions.

International considerations were critical in the crisis of 2007–08. The first special lending program introduced by the Federal Reserve — the Term Auction Facility — was dominated by foreign financial institutions. The TAF, introduced in December 2007, auctioned term credit from the Reserve Banks' discount windows. Foreign institutions held large dollar-denominated positions in illiquid assets, such as mortgage-backed securities, that they had trouble funding. Banks in the U.S. had access to borrowing from the Federal Home Loan Banks and made major use of that source of funds when credit risk premiums rose in the third quarter of 2007.

In the short run, it is possible that employment growth will be above 0.8 percent as we continue to recover from the recession. But we should also recognize some impediments to rapid employment growth. When the Affordable Care Act is fully implemented, it is likely to add to the cost of hiring an additional worker for many businesses, and firms are still trying to figure out just how costly that will be. Also, I've been struck by the large number of accounts I've heard recently about firms having difficulty finding workers with the appropriate skills, in many cases constraining production.


To summarize then, I think that in the short run, we are likely to see real GDP growth of 2 percent, or perhaps a bit higher. Over the longer run, we are likely to see growth average a bit below 2 percent.

The decision to taper is going to depend on the incoming data, and the phrase “in coming months” in the minutes, I felt, was about as precise as you can get at this point.

As reported by Dow Jones News

The spirit of the discussion last time was whether we could improve communications by providing a fuller sense to how policy is going to react to incoming data. [Officials should be] really cautious about tweaking the forward guidance apparatus [because the message is complex and changes may erode the Fed’s credibility]. If you go changing what you are saying about how you are likely to behave from time to time you could erode people’s confidence that you are going to follow through on what you say you are going to do.

As reported by Bloomberg News.

We should be clear that an interest rate near zero does not mean the Fed is paralyzed. By purchasing assets, we can increase the supply of monetary assets to the banking system, which in some circumstances can have a stimulative effect. The Fed has purchased significant quantities of assets since the end of 2008. The size of our balance sheet has gone from $2.2 trillion to around $3.9 trillion, and it continues to increase by about $85 billion per month.


The key issue, in my view, is the extent to which the benefits of further monetary stimulus are likely to outweigh the costs. Economic growth trends currently appear to be driven mainly by population growth and productivity growth, in which case monetary stimulus will only have limited and transitory effects. But further stimulus does increase the size of our balance sheet and correspondingly increases the risks associated with the "exit process" when it becomes time to withdraw stimulus. This is why I have not been in favor of the current asset purchase program.

Starting first with productivity: From 1983 to 2000, productivity grew at a 1.8 percent annual rate. But toward the end of the Great Moderation, productivity growth slowed, and over the last three years, productivity has increased at a very modest 1.0 percent annual rate. Forecasting trends in productivity growth is exceedingly difficult. Having said that, it's hard to see why productivity growth would improve dramatically in the near term; there's no sign of a major surge of technical innovation in the pipeline, significant educational improvement or substantial deregulation the kind of developments that would lead to a major acceleration in productivity. By the same token, it's hard to believe productivity has hit some sort of plateau. It doesn't take much digging to find examples of continued innovation in today's economy, even if it hasn't generated the rapid aggregate productivity growth we saw during the Great Moderation. The most likely outcome, in my view, is more of the same, and thus my outlook is that productivity growth will be about 1 percent for a considerable period.

By the same token, it's hard to believe productivity has hit some sort of plateau. It doesn't take much digging to find examples of continued innovation in today's economy, even if it hasn't generated the rapid aggregate productivity growth we saw during the Great Moderation. The most likely outcome, in my view, is more of the same, and thus my outlook is that productivity growth will be about 1 percent for a considerable period.

When the FOMC meets next week, I expect discussion about the possibility of reducing the pace of asset purchases. The key issue, in my view, is the extent to which the benefits of further monetary stimulus are likely to outweigh the costs. Economic growth trends currently appear to be driven mainly by population growth and productivity growth, in which case monetary stimulus will only have limited and transitory effects. But further stimulus does increase the size of our balance sheet and correspondingly increases the risks associated with the "exit process" when it becomes time to withdraw stimulus. This is why I have not been a supporter of the current asset purchase program.

As the Commission is well aware, there have been a number of high profile events in recent years that arose due to insufficient operational controls at trading firms and trading venues. Some of these have even caused market disruptions. While we recognize we do not live in an ideal world and there will never be a 100 percent error free trading environment, we do believe there is a need to develop quality standards related to the development, testing and deployment of ATSs and their components. Furthermore, many industries rely on standards setting bodies like the IEEE Standards Association and ANSI (American National Standards Institute) under ISO (International Organization for Standardization) to facilitate standards development yet there is no such corollary for the development of ATSs within a HFT environment. Therefore, we believe that market participants and the Commissions Technical Advisory Committee (TAC) should work together to formulate standards or guidelines for HFT that will help mitigate the impact of operational risks. We also note that many industry and regulatory groups have devised best practices for HFT. Nevertheless, many firms do not fully implement these best practices because they are not required to do so. We believe it would be beneficial for the Commission to work with the industry to define best practices for HFT and to communicate penalties for non-compliance with those best practices. We also believe disseminating information related to best practices could potentially reduce costs within the industry as firms learn through information sharing to avoid mistakes their peers have encountered. Finally, we believe the Commission should periodically engage with the industry to review and revise these best practices, as industry participants are generally the first to observe disruptive market events and to understand rapidly evolving technology.

The Federal Reserve's decision to slow its monthly bond purchases was justified by an improving labor market but the central bank could still adjust the pace of tapering based on incoming data, a top Fed official said on Monday. "I think the time was right," Richmond Fed President Jeffrey Lacker, a long-time critic of the Fed's monthly bond purchases, said in an interview on CNBC-TV. "Given the data....this decision was kind of a slam dunk." Lacker acknowledged that the Fed could still speed up or slow down the pace of stimulus withdrawal as needed. "You have to consider the door open to us pausing if the data comes in weaker than thought or accelerating if the data comes in stronger," he said, though he added that he would want to see a substantial change in current trends before pausing. "You don't want to over-react to a little swing" in the jobless rate, Lacker said.

During the Great Recession, GDP fell by 4.3 percent over a six-quarter interval, but other indicators document even greater hardship. Payroll employment fell by 8.7 million jobs in the recession and its immediate aftermath... The scale and scope of the loss in income and wealth experienced by Americans was far greater than anything seen in the previous 20 years. Given that experience, lenders are bound to re-evaluate the riskiness associated with extending credit to a typical household. Indeed, consumers themselves appear to be re-evaluating the riskiness associated with indebtedness, no doubt reflecting a sense that their income and asset returns may be substantially riskier than they had come to believe during the Great Moderation. Under these conditions, it's no surprise that credit is no longer available on the same terms. And it's no surprise that consumers have been paying off debt and building up savings in order to restore some sense of balance to their household finances... Businesses also appear to be quite reticent to hire and invest. A widely followed index of small business optimism fell sharply during the recession and has only partially recovered since then. Interestingly, when small business owners were asked about the single most important problem they face, the most frequent answer in the latest survey was "government regulations and red tape..." Adding to the uncertainty is the continuing cloud over our nation's fiscal policy. The most recent round of budget deliberations has certainly been a welcome relief from the recurrent legislative cliffhangers of the last several years. The lower odds of an imminent budget showdown may ease some business and consumer concerns, and that may aid growth. But overall government spending has been declining lately, and, given continuing fiscal pressures, that category is likely to make little, if any, contribution to GDP growth in coming years.

Payrolls in December increased at the slowest pace in almost three years, indicating a pause in the recent labor market strength that may have reflected the effects of bad weather. The drop probably won’t keep policy makers from discussing another $10 billion cut in asset purchases, Lacker told reporters today after a speech in Raleigh, North Carolina.

“As a general principle, it’s wise not to overreact to one month’s employment report,” Lacker said. “Employment has been growing along a pretty steady trend this year. It takes a lot more than one labor-market report to be convincing that the trend has shifted, and in my experience one employment report rarely has an effect by itself on monetary policy.”

“For me personally, it would take a very significant change in the outlook for me to support not tapering,” Mr. Lacker told journalists after addressing a meeting of the Risk Management Association here. “I don’t think the data we’ve seen so far are close to that,” he said.

Lacker, who votes on the Fed's policymaking Federal Open Market Committee in 2015, said he expects the first rate hike to come in early 2015.

Central bank actions constitute monetary policy if they alter the quantity of its monetary liabilities, often referred to as high-powered money. Central bank actions constitute credit policy if they alter the composition of its portfolio — by lending, for example — but do not affect the outstanding amount of monetary liabilities.

…

I’ll close with a reminder that establishing credible limits to central bank intervention in credit markets is critical to central banks’ core monetary policy mission. Entanglement in the distributional politics of credit allocation inevitably threatens the delicate equilibrium underlying central bank independence, which has been so essential to monetary stability. The fallout from the 2008 crisis vividly illustrates the risks to that equilibrium. The breakdown of that equilibrium in the 1970s provides vivid lessons in the dangers of credit allocation. Not only did Fed policymakers need to resist political pressure to lower unemployment, they also had their hands full resisting pressure to buy federal agency debt. The disastrous results for inflation are well known. Less well known is that by 1977, the Fed owned $117 million in debt issued by Washington, D.C.’s transit authority — with the bizarre result that the Fed wound up financing the construction of the Washington Metro.

Given the rescue expectations that have built up over the last several decades, I believe it will take more than a sincere pledge to limit central bank lending to solve the time consistency problem. The resolution planning provisions of the Dodd-Frank Act — often called “living wills” — require the creation of credible plans for resolving large institutions in bankruptcy without government funding. Work is underway implementing these provisions, but much more is needed. It’s worth emphasizing, however, that such plans should not take the current complexity and scale of large institutions as immutably given. The strategy should be to work backward from resolvability, without government funding backstops, to deduce how their current operations and funding need to be structured. Significant changes may be required, but resolution planning appears to be the only plausible way to dismantle “too big to fail.”

It's not obvious to me a larger balance sheet should change any of our exit principles... I still think we should, as our [2011] exit principles say, be exiting from mortgage backed securities as soon as we can, to reduce the extent to which we are allocating credit and distorting credit markets... I don't see any tremendous benefit to not doing what we said we would do.

Jeffrey Lacker says projections that the central bank will raise the benchmark interest rate next year are "reasonable... Getting the timing right is going to be tricky."

Since the end of the recession, real GDP has grown at an average annual rate of just 2.1 percent. In contrast, in the 60 years before the recession, real GDP grew at an average annual rate of 3.5 percent. Based in part on that long track record, many forecasters, myself included, were expecting growth to pick up to a more robust pace. More recently, however, I have come to the conclusion that a sustained acceleration of growth to something over 3 percent in the near future is unlikely. Given what we know, it strikes me as more likely that growth will continue to average somewhere between 2 and 2 1/2 percent. Let me briefly explain why.

It's helpful to start by thinking of the growth in real GDP as the sum of two components: growth in employment and growth in GDP per employee, a measure of productivity growth. When you calculate these two components, you find that both have slowed considerably since the Great Recession.

Taking these in turn, the rate of growth in employment has been about two-thirds of the rate we saw in the decades prior to the Great Recession. Part of that decline reflects structural developments such as slower growth in the working-age population, the aging of the baby boomers and the rise of enrollment in educational institutions. In addition, we've seen a gradual secular decline in the labor force participation rates for people in the prime working-age group aged 25 to 54. Some economists attribute this to workers becoming discouraged about their job market prospects and argue that the unemployment rate is understating the amount of "slack" in the labor market. Our research indicates, however, that there is always more slack than indicated by the standard unemployment rate, and by some measures there seems to be no more additional slack now than is typically associated with the current level of the unemployment rate.

Productivity growth, the other component of real GDP, grew fairly rapidly in the early postwar period, rising at a 2.7 percent annual rate from 1948 to 1969. Productivity growth then slowed, rising at a 1.4 percent annual rate from 1969 to 2007. And since the fourth quarter of 2007, productivity growth has averaged only 1.0 percent per year.

An active debate has sprung up concerning prospects for future productivity growth. Some economists have suggested that major, broad-based advances in technology are far less likely than in the past, and that we should prepare for a relatively stagnant productivity trend. I am not so gloomy, however, in large part because of the amazing historical record of technological innovations that solve current problems and simultaneously open up new possibilities for future innovations. Having said that, the difficulty of forecasting output per worker suggests that the middling productivity gains we've seen over the last few years are probably the best guide to near-term productivity trends. Thus, I am not expecting an imminent acceleration in productivity growth.

Productivity growth is critically important because it's what drives growth in real wages and real household income, which in turn ultimately drives consumer spending. Some proponents of the view that GDP growth will soon accelerate argue that a pickup in productivity growth will boost disposable income trends and thereby set off an acceleration in consumer spending. Data earlier in the year seemed to indicate that such an acceleration might be in train. More recent household spending figures suggest otherwise, however

The housing market has also perplexed forecasters over the course of this expansion Potential homebuyers now seem to be more conscious of the financial risks of homeownership than before, and housing demand has been shifting toward multifamily rental units. Moreover, the overhang of homes associated with foreclosures and seriously delinquent mortgages remains elevated, and this is dampening housing market activity. Thus, I am expecting residential investment to make only modest contributions to overall growth over the near term.

These three factors subdued productivity growth, moderate consumer spending growth and a more tempered expansion in housing construction are keys to my assessment that overall economic growth is likely to average between 2 and 2 percent over the near term, which is around the average rate we've seen for this expansion.

The Federal Open Market Committee is on record as stating that its goal is for the price index for personal consumption expenditures to rise at an annual rate of 2 percent. Many observers expressed concern last year that inflation, at about 1 percent, was running well below the FOMC's target. Inflation has averaged 2 percent over the last three months, however. While the inflation numbers will often run hot or cold for several months at a time, the latest numbers suggest that inflation has bottomed out and is moving toward the Committee's target. I expect that firming trend to continue this year.

Short-term interest-rate markets have for months priced in a slower tempo of increases than policy makers themselves forecast. Thats risky because the misalignment, a bet against a rate path that the central bank alone controls, could lead to volatility if traders have to adjust rapidly, Lacker said.

When there is that kind of gap, it gets your attention, Lacker, a consistent critic of the Feds record easing who votes on policy next year, said in an Aug. 1 interview at his Richmond office overlooking the James River. It wouldnt be good for it to be closed with great rapidity.

Investors may also be giving too much credence to a phrase in the Feds statement that even after employment and inflation are close to its goals, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.

They may be placing more weight on that than I think it deserves, said Lacker, who dissented against his colleagues at every meeting of the FOMC in 2012. They may think we have more conviction about that than we do.

Richmond Fed President Jeff Lacker said he believes the central bank will not raise its target for short-term interest rates until next year. In an interview in his office this week, Lacker called that scenario “pretty likely,” adding that he does not think the Fed is behind the curve in withdrawing its support for the nation’s economic recovery.

“I don’t see signs of that,” he said.

...

Lacker is a prime example. His dissents in 2012 were driven by two factors: discomfort with the Fed’s official commitment to keeping rates near zero and its purchases of mortgage-backed securities to help the housing market. The latter was an inappropriate use of Fed power, Lacker has long argued, in which the central bank effectively picked winners and losers in the credit markets.

“I think matters of very important principles are at stake,” he said in the interview. “We’re in uncharted territory with regard to the expansiveness of how people talk about what the central banks can do and ought to do.”

And after the recession ended, that sense has led many forecasters, myself included, to predict repeatedly that growth was about to shift to a more robust pace. That just hasnt happened; weve seen short-lived surges in growth, only to see growth subside for the following couple of quarters. For example, real GDP surged over the second half of last year only to falter at the beginning of this year.

This experience has led me to conclude that a sustained increase in growth to something over 3 percent in the near future is unlikely. Given what we know, after more than five years of this expansion, it strikes me as more likely that growth will continue to average somewhere between 2 and 2 percent.

I would like to highlight some work by Richmond Fed economists Andreas Hornstein and Marianna Kudlyak and Professor Fabian Lange of McGill University. In a recent paper they authored with Tim Sablik of the Richmond Fed, they have developed a new and intuitively appealing approach to estimating the extent of labor underutilization

They construct what they call a Non-Employment Index by taking each category of persons who are not working and weighting them by their propensities to become employed. This provides a unified framework for viewing the non-employed population that addresses many of the objections that have been raised to the conventional unemployment rate. They also take an improved approach to incorporating part-time workers by taking into account that the underutilization of a person working 20 hours per week is less than the underutilization of a person working zero hours.

Movements in their Non-Employment Index over time closely track movements in the conventional unemployment rate In particular, the Non-Employment Index is about where it should be based on past episodes when the standard unemployment rate was about 5.9 percent.

This research supports the conclusion that the standard unemployment rate by itself is still a reliable indicator of the degree of labor underutilization. There is more underutilization than captured by the unemployment rate, but there always is, and there seems to be no more now than is typical when the unemployment rate is where it is now.

Innovative new opportunities for risk-taking will always emerge as financial markets and economies evolve, and it is asking too much to expect front-line supervisors to forever substitute for well-aligned incentives. Moreover, stronger restraints on risk-taking increase the incentive for market participants to find a way to operate beyond the scope of regulation. Expanding regulation to chase down fragility wherever it appears is not a promising strategy.

I also believe, however, that as long as regulators retain the discretion to intervene with government funding, the credibility of resolution plans will be at risk. Seemingly urgent short-run considerations will threaten to overshadow the value of establishing and preserving a record of precedents that keep market expectations well-anchored. This is a particular danger for central banks, whose independent balance sheets place their fiscal actions beyond the scope of the legislative appropriations process.15 Credible commitment to orderly unassisted resolutions thus may require eliminating the power of governmental entities to provide ad hoc rescues. This would mean repealing the Federal Reserve's remaining emergency lending powers and further restraining the Fed's ability to lend to failing institutions. And once robust and credible resolution plans are in place, we would be able to responsibly wind down the FDIC's Orderly Liquidation Authority and related financing mechanisms.

Our objective is to keep inflation under control, so keep it averaging 2 percent, Lacker said today in an interview with Kathleen Hays on Bloomberg Radio. So to my mind, that doesnt mean it has to cross two before the Fed raises rates

It wouldnt surprise me to see softer inflation for a couple of months, but I think if you look a year out, I think well be at 1.5 or higher, Lacker said

Inflation is, I think, a key swing variable in the outlook for when the Fed will raise its benchmark policy rate from zero, where it has been since 2008, Lacker said.

The unemployment rate has continued to decline, and so I think thats dramatically reduced the extent to which we ought to be sort of unhappy about labor market conditions and our employment mandate, he said. On the other hand, inflation has run below two for quite some time now, and the longer that goes on, the more you ought to focus on inflation.

What we have is a fundamental flaw in the relationship between government and the financial sector resulting from the inability or unwillingness to find a way to forgo intervention in crises. And the impact of this flaw is growing. At the end of 1999, the government safety net including both the implicit support I just outlined and explicit support provided by programs such as deposit insurance and pension guarantees covered 45 percent of financial sector liabilities, according to Richmond Fed researchers. By the end of 2011, that number had grown to 57 percent, about the same size it was at the end of 2009, despite the many new regulations we have put in place since the crisis.

Greater capital buffer requirements and measures to beef up ex-ante constraints on risk-taking are important, but theyre not infallible. New opportunities for risk-taking will always emerge as financial markets and economies evolve, and it is asking too much to expect front-line supervisors to forever substitute for well-aligned incentives. Moreover, stronger restraints on risk-taking increase the incentive for market participants to find a way to operate outside the regulated sector. This regulatory bypass gives rise to whats come to be called shadow banking

a topic we will be hearing more about this afternoon

The Dodd-Frank Act lays out a path toward making bankruptcy workable for large financial institutions. The Act requires these institutions to create resolution plans, also known as living wills. These are detailed plans that explain how a financial institution could be wound down under U.S. bankruptcy laws without threatening the rest of the financial system or requiring government assistance. The plans explain how to disentangle the many different legal entities sometimes numbering in the thousands that make up a large financial firm. Under the Dodd-Frank Act, large banks and other systemically important firms are required to submit these plans on an annual basis for review by the Fed and the FDIC.

Resolution planning provides a structured approach for understanding whats likely to happen in the event a large financial firm fails. In contrast, in past crises policymakers found themselves with little or no preparatory work to draw on. In fact, the process has already proven valuable by giving firms a better and more detailed understanding of their legal structure, and many have used the process to reorganize themselves and eliminate unneeded legal entities.

Resolution planning wisely does not take the current operating profile of large financial firms as given; the current characteristics of these firms evolved in response to the precedents set by regulators avoiding the use of bankruptcy.

That basic framework pertains to how the Fed intends to move toward more normal levels of interest rates and asset holdings. I suspect some of you are just as avidly interested, if not more so, in when and how rapidly the Fed will raise rates. I hate to disappoint you, but the truth is nobody knows yet. There is no pre-set timetable for raising rates. The FOMCs actions genuinely will depend on the economic data available at the time. So I cannot tell you when and, more importantly, how rapidly our rate target will rise.

I will share an observation, however. The economic outlook can change rapidly, and judgments about appropriate policy need to respond accordingly. Its not hard to find historical examples: The outlook for real activity shifted dramatically from late 1998, when overseas turmoil was thought to jeopardize U.S. growth, to early 1999, when it became clear that the effects would be minimal and activity was accelerating. Similarly, the outlook for growth and inflation shifted significantly from mid-2003, when inflation seemed to be sinking below 1 percent, to early 2004, when growth and inflation were clearly rising. Arguably, the Fed fell at least somewhat behind the curve in each case. The lesson, I believe, is that policymakers should strive to look through clearly transitory phenomena to assess the underlying real economic developments that as long as inflation is anchored determine the appropriate path for interest rates. And they need to be prepared to respond promptly.

"At this point, raising rates in June looks like the attractive option for me," Federal Reserve Bank of Richmond President Jeffrey Lacker told reporters on Tuesday after giving a speech in Raleigh, North Carolina. "Data between now and then may change my mind, but it would have to be surprising data."

Developments in China appeared to have heightened uncertainty regarding future economic growth and macroeconomic policy there, which seems to have prompted higher financial market volatility in developed market economies. At times of market turbulence one must maintain a deep respect for the divergent ways in which events could conceivably unfold, and thus I will not pretend I can foretell the future.

Nevertheless, it is worth observing that the direct implications of recent developments for economic fundamentals in the United States appear to be quite limited. If so, then recent market developments will have only limited implications for the appropriate path of monetary policy. This might seem to contradict widespread conjecture about the Fed delaying liftoff due to market turbulence. But I would point out that the Fed has a history of overreacting to financial market movements that seem unconnected to economic fundamentals. The events of 1998-99 are a case in point, when financial developments in emerging markets generated substantial U.S. market volatility despite limited identifiable implications for U.S. growth. The FOMC cut rates three times but ended up taking back those cuts the following year.

I was also willing to wait for confirmation that the factors holding down real growth and inflation late last year and early this year were transitory. It is now clear that those factors, which included harsh winter weather, the strengthening dollar, and the steep decline in energy prices, have dissipated. It was not unreasonable to seek more definitive evidence that these impediments to growth and price stability had passed, but that question has now been settled.

I dissented because I believe that an increase in our interest rate target is needed, given current economic conditions and the medium-term outlook. Household spending, which has grown steadily since the recession, has accelerated in the last couple of years. Labor market conditions have steadily improved as well and have tightened considerably this year. With the federal funds rate near zero and inflation running between 1 and 2 percent, real (inflation-adjusted) short-term interest rates are below negative 1 percent. Such exceptionally low real interest rates are unlikely to be appropriate for an economy with persistently strong consumption growth and tightening labor markets.

A higher interest rate under current conditions is also consistent with the way the FOMC has responded to economic conditions and inflation over the last few decades. This historical pattern of behavior has conditioned public beliefs about how the FOMC is likely to behave in the future, and it has been an essential foundation for the monetary stability we currently enjoy. Further delay would be a departure from a pattern of behavior that has served us well in the past. The historical record strongly suggests that such departures are risky and raise the likelihood of adverse outcomes.

I dissented because I believe that an increase in our interest rate target is needed, given current economic conditions and the medium-term outlook. My assessment is essentially unchanged from the Committee’s September meeting, at which I also dissented. My reasoning was based on my belief that with the steady growth in output and household spending that we have been observing — and expect to continue — the real (inflation adjusted) rate of interest should be higher than its current level of less than negative 1 percent. My assessment was also supported by labor markets that had tightened considerably and my confidence that inflation will return to our 2 percent objective after the temporary effects of low energy and import prices have passed.

NY Times: You’ve said you were ready to raise rates six months ago. Do you think the Fed will now need to raise rates more quickly?

Lacker: It’s too soon to tell. I think there’s a chance we are behind the curve, but it will be a year or two before we figure that out. With the anticipation that we’re likely to raise rates gradually and the committee having signaled that expectation, I think we have room to accelerate if we find out that we wish we’d started earlier.

NY Times: Ms. Yellen has suggested the Fed is likely to raise rates by about one percentage point per year. Is that fast enough?

Lacker: That’s a plausible pace for me, but if I picked a number it might be a little higher than that, a little more rapid than that.

I continue to hold the view, as expressed in the FOMC’s statement of long-term goals, that monetary policy has the unique ability to determine inflation over time. That ability is independent of whether or not there is a reliable Phillips curve correlation. Moreover, it remains true in a world with interest on reserves and large bank reserve account balances. The effect of monetary policy on real activity, on the other hand, is likely to be transitory, which suggests caution in trying to use monetary policy to have significant real effects over the medium term. Even more caution should apply, given the state of our understanding, to the notion that monetary policy should respond to signals of incipient financial instability, an idea that has received considerable attention since the crisis.

I don’t see anything I would call a bubble. People use that word, obviously, as something that’s going down real soon. So far, things seem pretty manageable, so I don’t see something that’s so out of whack.

Federal Reserve forecasts pointing to four interest rate hikes in 2016 show what the U.S. central bank means when it says it anticipates raising rates at a "gradual pace," Richmond Fed President Jeffrey Lacker said on Friday.

"That's half the rate at which we raised rates in the last tightening cycle. So that's what 'gradual' means to me," Lacker told reporters in Charlotte, North Carolina after participating in a business panel discussion.

“In short, inflation has been held down by two factors, the falling price of oil and the rising value of the dollar,” he said. “But neither factor is likely to depress inflation indefinitely. After the price of oil bottoms out, I would expect to see headline inflation move significantly higher. And after the value of the dollar ultimately tops out, core inflation should move back toward 2 percent.”

If oil prices and the dollar stabilize, but inflation doesn’t quickly respond, “a shallower path for interest rates would make sense,” Lacker said. “If inflation moves rapidly back toward 2 percent, however, a more aggressive path would be in order.”

Richmond Fed President Jeffrey Lacker said the Asian financial crisis of the late 1990s, which helped prompt interest rate cuts by the U.S. central bank, was a "great analogy" for viewing the current situation.

"People overestimated the implication of the Asian market volatility for U.S. growth and we overreacted," Lacker told reporters after a speech in Baltimore. "And I think we have to be careful not to overreact without evidence of significant effects on U.S. fundamentals."

The important point to recognize, however, is that actual real interest rates — at about negative 1 ¾ percent — are now substantially below estimates of the current natural rate, which as I noted are around zero. Moreover, while the natural interest rate is lower than usual right now, over time one might expect it to rise as it reverts toward its longer-run mean. So despite the relatively low natural real interest rate, there are still strong reasons to expect real short-term interest rates to rise in the near term.

The broad takeaway, I’d suggest, is that even though interest rates are likely to be lower than usual for the next few years, monetary policy is still highly accommodative right now. Interest rate increases within the range envisioned by FOMC participants would be relatively slow by historic standards, and would still leave policy in an accommodative stance.

A central bank can use its balance sheet to alter the allocation of credit in the economy. By lending to or buying the securities of private sector entities, central bank credit allocation can cause more resources to flow to those segments of the economy than would otherwise be the case. This deprives other sectors of resources, however, and may distort economic activity in a way that is unproductive. Importantly though, I would not characterize central bank credit allocation as monetary policy, but rather as fiscal policy. As a result, I believe it is appropriate for such actions to be taken only by elected branches of government, not by the central bank.

This is why I have dissented on FOMC decisions to purchase securities backed by home mortgages.

Current estimates of the natural rate of interest in the United States are subject to a fair amount of uncertainty, but most are clustered at or just above zero. This is well above the actual real funds rate, which has been running below negative one. So at this point, estimates of the natural real rate of interest do not suggest that the zero lower bound is impeding the Fed’s ability to attain its 2 percent inflation objective. In fact, this perspective would bolster the case for raising the federal funds rate target.

Inflation has been held down recently by two factors, the falling price of oil and the rising value of the dollar. But neither factor is likely to depress inflation indefinitely. After the price of oil bottoms out, I would expect to see headline inflation move significantly higher. And after the value of the dollar ultimately tops out, core inflation should move back toward 2 percent. Although recent declines in inflation compensation do give me some pause, I think the evidence indicates that inflation expectations (as opposed to inflation compensation) remain well-anchored. Therefore, I am reasonably confident that, barring subsequent shocks, inflation will move back to the FOMC’s 2 percent objective over the medium term.

My own view, as I will discuss today, is that the medium-term U.S. outlook has not changed materially since December. If anything, inflation seems to be returning to our 2 percent goal somewhat more rapidly than expected. As a result, my sense is that the less leisurely but still gradual pace of target rate increases that FOMC participants submitted at year-end is still more likely to be appropriate.

When the Fed has delayed needed policy adjustments in the past, it has often been in response to financial market developments that turned out, with hindsight, to be false signals. The record shows that if we delay too long or raise rates too slowly, we run the risk of needing to make larger, potentially more disruptive rate increases in the future. Given the extent to which global risks to the United States have subsided, prudence suggests staying the course with a gradual sequence of rate increases.

I think the [April] minutes did a good job of conveying the breadth of expectation within the committee about what they would be likely to favor doing in June given the data coming in as expected. I thought that passage was clear. I thought it was accurate.

I thought it was a good reflection of the extent to which, yes, I think if we did come in with data that along the lines we're expecting a pickup of growth in the second quarter, inflation kind of remaining where it is now, or maybe advancing further towards two percent measured by the PCE index, I think the case should be very strong for raising rates in June as well.

MCKEE: Very quickly, let me ask you, last question, Donald Trump says he would get rid of Janet Yellen and appoint someone who shares his views on interest rates and policy. What would that mean for Fed credibility?

LACKER: I think it would be problematic for a presidential candidate to dismiss a Fed chair on the basis solely of the perceived party affiliation.