By Steven K. Beckner

Chicago Fed President Charles Evans said “we still need to
experience a good deal of growth before we return to the more normal
pace of economic activity and levels of unemployment that we enjoyed in
late 2007.”

Evans warned unemployment may stay “stubbornly high,” cited
“reduced availability” of bank credit as a “significant headwind” and
anticipated “inflation will remain relatively stable.”

Against that backdrop, Evans called monetary policy “appropriately
very accommodative” and said Fed policy will stay as is for “3-4
meetings, which translates into about six months.” He has been making
similar comments all year.

Minneapolis Fed President Narayana Kocherlakota, who will get his
first crack at bat voting on the FOMC next year, said he expects the
economy will continue to grow by about 3%, but said he is “concerned
about the ongoing lack of vitality in the American labor market.”

“Unemployment is always slow to recover after recessions,”
Kocherlakota said. “However, its recovery seems likely to be even slower
than usual this time, because of weakness in the banking sector.”

“Bank lending continues to be highly subdued … ,” Kocherlakota
continued. “These difficulties in the banking sector are likely to
persist for the next year or even two.”

Kocherlakota told a business audience that “the challenges in the
banking sector affect job creation in ways that matter for you as
entrepreneurs. Banks provide the majority of credit used by small
businesses. Small businesses are an important source of job creation
during economic recoveries. Thus, the challenges for banks translate
into difficulties for small businesses in obtaining requisite credit and
into slower job creation for our country.”

“With all of these factors in play, I would be surprised if the
national unemployment rate were to fall below 9% before the end of 2010
or below 8% by the end of 2011,” he added.

With that, Kocherlakota echoed the same two “headwinds” — weak
labor markets and credit constraint — which Bernanke has been talking
about all year.

And lately there has been a third putative headwind: the European
debt crisis.

In preparation for the FOMC meeting, the Fed has been asking top
Wall Street firms their views on the economic and financial impact on
the U.S. economy.

Views have diverged among private economists and among Fed

Fed Governor Daniel Tarullo was quite negative about the potential
impact of the European debt crisis in late May: “Coming as it does on
the heels of the financial crisis that began in 2007, and with economic
recovery here in the United States proceeding at only a modest pace, the
European sovereign debt problems are a potentially serious setback.”

“In addition to imposing direct losses on U.S. institutions, a
heightening of financial stresses in Europe could be transmitted to
financial markets globally,” Tarullo told Congress. “Increases in
uncertainty and risk aversion could lead to higher funding costs and
liquidity shortages for some institutions, and forced asset sales and
reductions in collateral values that could, in turn, engender further
market turmoil.”

“In these conditions, U.S. banks and other institutions might be
forced to pull back on their lending,” Tarullo continued. “The timing
of such an event in the current instance would be unfortunate, as banks
generally have only recently ceased tightening lending standards, and
have yet to unwind from the considerable tightening that has occurred
over the past two years.”

“Moreover, aggregate bank lending, particularly to businesses,
continues to contract,” Tarullo went on. “The result would be another
source of risk to the U.S. recovery in an environment of still-fragile
balance sheets and considerable slack.”

Tarullo also warned the European crisis could hurt the U.S. economy
via the trade route. He said “a moderate economic slowdown across Europe
would cause U.S. export growth to fall, weighing on U.S. economic
performance by a discernible, but modest extent.”

“However, a deeper contraction in Europe associated with sharp
financial dislocations would have the potential to stall the recovery of
the entire global economy, and this scenario would have far more serious
consequences for U.S. trade and economic growth,” he said. “A resultant
slowdown in the United States and abroad would likely also feed back
into the health of U.S. financial institutions.”

“With unemployment remaining quite high, and with continued need
for balance sheet repair by many businesses, financial institutions, and
households, it is particularly important that the United States not
sustain a significant external shock,” Tarullo added.

-more- (2 of 3)

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