By Steven K. Beckner
RICHMOND, Va. (MNI) – One of the objectives of Federal Reserve
policymakers in expanding bank reserves and extending the period of
near-zero short-term interest rates in September was “to depreciate the
dollar,” Richmond Federal Reserve Bank President Jeffrey Lacker said
But in its efforts to stimulate the economy by this and other
means, the Fed is running the risk of eroding public and market
confidence in its commitment to price stability, and this could lead to
accelerating inflation, Lacker warned in an exclusive interview with
Already, there are signs of higher inflation expectations, although
they have not yet “broken out,” he said from the vantage point of his
office overlooking the James River.
Lacker seemed particularly concerned about the kind of message the
Fed’s policymaking Federal Open Market Committee sent on Sept. 13 when,
for the first time, it said it “expects that a highly accommodative
stance of monetary policy will remain appropriate for a considerable
time after the economic recovery strengthens.”
That statement was made in conjunction with an extension of the
anticipated zero federal funds rate period to “at least through
mid-2015.” At the same time, the FOMC announced it would buy $40 billion
per month of mortgage backed securities until labor markets improve
“substantially” — on top of continuing the $45 billion-per-month
“Operation Twist” program of Treasury bond purchases through year-end.
Lacker, who dissented against those actions as he has all year,
doubted they will do much to boost the economy, but said they could
worsen inflation over time.
He said he does not expect inflation to run either much below or
much above the Fed’s 2% inflation target in the coming year, but said
the latest monetary stimulus measures do “pose upside risks to the
inflation outlook for the next few years.”
MNI asked Lacker about signs of rising inflation expectations both
in the bond market and in the foreign exchange market, where the dollar
has fallen in value relative to a basket of currenices.
“I think the FOMC’s policy initiative in September was designed in
part to depreciate the dollar, and I don’t think there’s any question
about that, among other things,” Lacker said. “That’s one of the usual
effects of monetary stimulus.”
MNI has reported for several years that the Fed expected its low
rate policies to stimulate the economy through the exchange rate
channel, as well as through the interest rate and asset wealth
channels. But Fed officials don’t ordinarily talk publicly about the
dollar or its role in monetary policy.
The exchange rate effects of Fed policy came under considerable
criticism at the recent annual meetings of the International Monetary
Fund and World Bank in Tokyo. Brazilian Finance Minister Guido Mantega
and others accused the Fed of using “quantitative easing” to reduce the
value of the dollar to help U.S. exports at the expense of emerging
market nations. Mantega charged the Fed is exporting inflation to his
Fed Chairman Ben Bernanke countered that the central banks of
emerging market nations should adopt more flexible exchange rate
regimes and allow their currencies to appreciate rather than
resisting appreciation through intervention that increases their
money supplies and creates inflation pressures.
Lacker also pointed to a “noticeable” increase in inflation
expectations, as measured by various surveys and by spreads between
Treasury’s conventional and inflation protected securities (TIPS).
“It got my attention,” he said.
Lacker said inflation expectations are still “in the trading range
of the last 5-10 years,” so “I don’t think it’s broken out yet.”
But he added, “It does seem to represent, I think, a perception on
the part of financial market participants that our commitment to price
stability may have diminished, and that’s worrisome to me.”
Lacker warned that the Fed’s recent communications strategems
could further erode the Fed’s credibility as an inflation fighter and
fuel inflation expectations.
He was asked whether the FOMC’s statement of its intent to hold
rates low “for a considerable time” even after the recovery strengthens
could heighten perceptions that the Fed will overstay its easy money
“It’s hard to predict what we’re going to do,” he responded, but
“the signal sent by that phrase … could be misconstrued as a
willingness to tolerate higher inflation.”
Lacker, who expects real GDP growth to pick up from 2% to between
2.5% and 3% later next year, said “the time in the recovery when growth
picks up measurably..is always the tricky part; it’s always the part
where we’re in the most danger of having inflation and inflation
expectations ratchet up.”
He recalled that in the 2003-04 period, because Fed policymakers
thought the output gap was so large that inflation wasn’t a serious
problem, “we tolerated an acceleration of inflation and what in
hindsight became a sustained miss on inflation.”
By contrast, in 1994, Lacker recalled that the Fed tightened
credit preemptively to counter inflation pressures even though the
unemployment rate was 7.1% because the rate of GDP growth picked up.
A woeful Lacker suggested the current FOMC is more likely to follow
the 2003 than the 1994 path.
“When I look at that (FOMC) language (on holding rates low past the
point of faster growth), I worry that people will think we’re going to
wait for growth to pick up and then we’re going to wait some more.”
That kind of thinking is sure to fuel inflationary psychology, he
“I worry people think we’re going to wait too long,” he said.
In deciding how long to hold rates down, the FOMC majority made it
fairly clear it will focus primarily on labor market conditions. But
Lacker warned that the Fed should focus less on the unemployment rate
and more on the GDP growth rate.
“We look at a broad array of indicators,” he said, but “from my
perspective indicators related to the rate of growth are going to figure
more prominently than indicators like unemployment (and other) resource
“The economics are pretty clear that where interest rates need to
head need to be guided by the rate of growth rather than the level of
activity relative to some benchmark,” Lacker continued.
“If we miss, if we get behind the curve, it’s going to be
challenging,” he warned, “because …if you look over the last 20 years
we’ve had inflation averaging very close to 2% but fluctuating
significantly around that.”
“If we get behind the curve — if policy does become too easy —
it’s going to show up with inflation rising,” he went on. “But at first
it will be unclear whether that’s a sustained upward movement of
inflation. It will be hard to disentangle a transitory blip” from a more
As the FOMC awaits “substantial” improvement in labor markets
before ending QE3, Lacker warned that the unemployment rate can be a
misleading indicator on which to make such a judgment — particularly
because of uncertainty about trends in labor force participation.
“The shape of the underlying trend (in labor force participation)
is very uncertain,” he said, citing shifts in female participation. “So
it’s really hard to judge how much of the fall in labor force
participation is trend and how much is recession.”
“It’s hard to know how much labor force growth will pick up when
employment growth picks up and keep the unemployment rate elevated
despite employment growth picking up,” he said, “in which case I
wouldn’t want to pin policy to a fall in the unemployment rate to a
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** MNI **