By Steven K. Beckner

ATLANTA (MNI) – Atlanta Federal Reserve Bank President Dennis
Lockhart defended the Fed’s extended zero federal funds rate policy
Thursday but expressed doubt whether a third round of large-scale asset
purchases — “quantitative easing” — would do much good.

Lockhart, a voting member of the Fed’s policymaking Federal Open
Market Committee this year, said very low interest rates and the
ballooning of bank reserves have not resulted in much expansion of bank
credit because the normal “monetary transmission channels” are clogged.
As a result, economic growth and job creation have been slow.

But the economy “is gaining strength,” Lockhart said in remarks
prepared for delivery to an Atlanta Fed banking conference, but the
recovery is “still getting its legs” and is overhung by a shadow of
doubt about its “sustainability.”

So “monetary policy support remains an important and necessary
contributor to the ongoing recovery.”

Although some of his FOMC colleagues have argued against keeping
the funds rate near zero “through at least late 2014,” Lockhart
indicated he is comfortable with that so-called “forward guidance.”

“Given the circumstances of the economy … I continue to think the
benefits of the low rate policy outweigh the costs,” he said.

“I take seriously the risks of holding to this policy,” he said.
“But I think a realistic assessment of the challenges associated with
closing the employment gap call for sustained extraordinary support for
what is, like it or not, a gradual process.”

But QE3 is another matter.

“At the same time, I’m cautious about doing more involving
expansion of the Fed’s balance sheet,” Lockhart said. “Precisely because
I see the transmission mechanism of monetary policy through credit
channels as constricted, I have my doubts that the gains from such a
policy action taken in the near term would outweigh the longer-term
potential costs, including the risk to the Fed’s medium-term inflation
outlook.”

Earlier, Lockhart echoed many of his Fed colleagues in observing
that “the transmission mechanism of monetary policy is — choose your
adjective — broken, clogged, impaired.”

This “clogging” of monetary transmission channels “means low rates
aren’t stimulating much in the way of credit growth,” he said. “It means
some bankable loan demand is not being met in spite of ample liquidity.
And it means final demand for goods and services remains subdued and the
added employment that growing final demand ought to generate is slow to
materialize.”

Lockhart said both supply and demand factors are inhibiting bank
lending.

The net result is that “low funding costs and abundant bank
reserves produced by monetary policy still have not resulted in
significant, broad-based loan growth,” he said, although he noted there
has been “some movement in the right direction.”

Lockhart noted that some policymakers have reacted to the
“clogging” by saying that the Fed “should push harder to compensate for
the weakened transmission mechanism.” But others think “further easing
involves an element of futility or even potential harm.”

“Some have argued, for example, that pushing harder to increase
aggregate demand would not be a good thing because the economy’s
potential level of output is actually lower than conventional estimates
suggest,” he elaborated. “Accelerating demand, then, is more likely to
compromise the Fed’s price stability mandate than to improve the
prospects for lower unemployment.”

“Another argument is that the elements of recent policy designed to
suppress long-term rates challenge long-term lenders and investors,
including life insurance companies and pension funds,” he observed.
“With respect to the banking channel, what could be a six-year period of
very low rates poses a risk-management challenge.”

“The argument goes, with short-term rates close to zero, banks may
see their exposure to interest rate risk as outsized,” he continued.
“This potential interest rate risk could cause banks to grow loan
activity more slowly-or, it is argued, meager yields will just spur
imprudent risk.”

Lockhart said that, as an FOMC voter, he will “weigh these
divergent views and the policy stances they suggest by asking what
policy balance will promote the most robust sustainable growth and the
healthiest overall employment markets in the context of price
stability.”

Lockhart said he looks for 2.5% to 3.0% growth this year provided
there are “no significant adverse shocks.”

As for inflation, he said it “appears to be tracking along a path
that is consistent with my interpretation of price stability. And
inflation expectations appear stable.”

But he added that “gasoline prices are on the rise again, and cost
pressures-both positive and negative-warrant a watchful eye for any
shift in the underlying overall inflation trend.”

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

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