By Suzanne Cosgrove

EVANSTON, Ill. (MNI) – Chicago Federal Reserve President Charles
Evans said Tuesday that a Federal Reserve policy that embraces both QE2
and price-level targeting would be appropriate, and would go well
together.

In response to questions from Evanston civic leaders after speaking
at a breakfast meeting, Evans said even if the Fed adopts a second round
of quantitative easing, policymakers can remain accommodative not only
for an extended period but “until prices begin to rise.”

He added that he is “comfortable” with the Fed’s balance sheet
regarding QE2, which would involve large-scale asset purchases. Adding
that the Fed’s purchases also are a way to communicate to markets
and lenders, Evans said they would raise inflation and so increase the
“opportunity costs” of holding cash and encourage lending

Answering reporters’ questions after the address, Evans reiterated
his call for price-level targeting, which includes allowing inflation to
rise. He said there is much evidence that the U.S.economy is in a unique
state that happens perhaps “twice in a century,” and the Fed wants to
see “more lending, more spending, and more employment growth.”

As for inflation pressures and the Fed’s dual mandate to bring
employment growth up to sustainable levels and control inflation, Evans
said an inflation rate of under 1% in 2012 and just 1.5% in 2013 is a
strong possibility — well below the Fed’s target rate of 2%.

A policy that includes price-level targeting would provide
additional information on the question of how much more easing is
needed, Evans told reporters. Asked when the Fed should more to further
policy accommodation, he said the need to act is now.

Evans said the current 9.6% rate of unemployment is “well above”
that that can be attributed to structural shifts in the economy. Asked
about global commodity prices, which are generally on an upswing, Evans
was upbeat. He said the price increases reflect stronger global demand,
and that “stronger growth worldwide would help our economy grow.”

Earlier, in his prepared remarks, Evans underlined his preference
for more aggressive Fed accommodation.

“We have all the ingredients for a liquidity trap,” he said.
“Businesses are cautious about new investment and households are too
worried to meaningfully increase consumption. And interest rates can’t
fall in the way needed to increase investment and consumption because
short-term rates are already at zero.”

“Rare occasions of liquidity traps are very different from typical
economic recessions,” he continued. “Consequently, they require a unique
monetary policy response,” with his preferred target the
inflation-adjusted interest rate.

“This higher inflation rate would decrease the real interest rate,
raising the opportunity cost of holding money,” an “incentive for banks
and corporations to release funds for investment, and in the process
spur job creation.”

“Practically speaking, price-level targeting in the current
environment would call for a series of large-scale asset purchases to
recover the shortfall in inflation. At the same time, we would continue
to carry a large balance sheet in order to maintain low interest rates
for an extended period,” he said.

“We’d need careful advance planning to ensure that if inflation ran
at a more elevated level than expected, we could bring the price level
back to the target path,” Evans said. All the while, he added, “It would
also be of utmost importance to appropriately use the Federal Reserve’s
authorities of macroprudential supervision and regulation during this
period to avoid the emergence of financial market imbalances.”

** Market News International Chicago Bureau **

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