By Steven K. Beckner

WASHINGTON (MNI) – Minneapolis Federal Reserve Bank President
Narayana Kocherlakota said Thursday that the economy is still being
restrained by dual “headwinds” and doubted whether there will be much
improvement in the labor market this year.

Kocherlakota, a voting member of the Fed’s policymaking Federal
Open Market Committee, did not address the outlook for monetary policy
but he has recently called himself “very comfortable with our current
monetary policy stance.” And his latest fairly downbeat comments do not
suggest any inclination to firm policy in the near future.

“Even with the December changes in fiscal policy, I would say that
I expect that real GDP growth will probably be closer to 3% than 4% in
2011,” he said.

Kocherlakota, in remarks prepared the University of Minnesota in
St. Paul, said he “still sees two major headwinds in the U.S.
economy.”

“The first is that many households will continue to strive to
rebuild their net worth positions in response to past — and possibly
future — falls in residential land prices,” he said. “I believe that
the decline in household net worth, precipitated by falls in land
values, was a key factor in generating the severity of the Great
Recession. It will remain important in the recovery.”

“The second headwind is related,” Kocherlakota continued. “Many
banks in the United States face ongoing issues with asset quality.” The
FDIC problem-bank list contains over 800 banks, he noted.

“Problem banks are less likely to take the risk of lending to small
and/or younger firms and other entrepreneurial activity,” he said.
“Instead, they are more likely to preserve capital ratios by limiting
their asset growth and allocating their lending staff to working out
loans to existing borrowers.”

“Indeed, as the economy improves, I suspect that this headwind will
become even more important,” he added.

Kocherlakota said the Minneapolis Fed has found that “small
businesses were reluctant to expand because of ongoing uncertainties
about product demand. As a result, their demand for bank financing
remained low.”

“In 2011, as the economy improves, I expect loan demand to rise
accordingly — but banks with poor asset quality will continue to focus
on capital preservation rather than loan expansion,” he said.

Although the unemployment rate fell from 9.8% to 9.4% in December,
Kocherlakota said he does “not think this single data point signals a
rapid recovery in labor markets. Employment growth remains
disappointingly low-nonfarm employment increased by only 103,000 in
December.”

“I do not believe that either unemployment or employment will
improve rapidly in 2011,” he said, adding that he agrees with the FOMC’s
November central tendency forecast that unemployment will remain above
9% throughout this year.

“Even more troublingly, I expect too that unemployment is likely to
be higher than 8 percent as late as the end of 2012,” he added.

As for inflation, Kocherlakota called it “extraordinarily low” and
said “these inflation levels are too low to be consistent with usual
formulations of the Fed’s price stability mandate.”

Kocherlakota said he is “optimistic that inflation will actually
turn north in 2011.”

** Market News International Washington Bureau: 202-371-2121 **

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