By Steven K. Beckner
CHICAGO (MNI) – Chicago Federal Reserve Bank President Charles
Evans indicated Friday he is less concerned about inflation risks than
some of his colleagues, but that he is not complacent.
He acknowledged that food and energy prices have soared, but he
called this “a relative price shock” caused by external events, most
notably turmoil in the Middle East.
The Fed’s job, he suggested, is to make sure that it doesn’t
accommodate a more general rise in prices by keeping monetary policy too
loose for too long.
“We’re very mindful of the fact that prices are higher, and what we
want to be careful of in terms of monetary policy is that any first
round price increases don’t find their way into second round price
increases for all the other goods and services,” he said. “Then it would
truly be inflation.”
For now, though, that is not the issue. “At the moment we continue
to have good deal of heterogeneity” in price movements, with some prices
not rising or even falling.
“If we had strong inflationary pressures we would see other prices
going up,” he said.
What’s more, he said, “if we were really experiencing strong
inflationary pressures we would be seeing strong increases in wages.”
But that is not happening because of the large amount of slack in labor
markets and low rates of capacity utilization.
Nevertheless, Evans said “we want to make sure any second round
effects are minimal” and “mitigate that.” He said the Fed will “have to
monitor those effects” because resource slack “will be receding over
time.”
If second round inflation effects do emerge, “we would be very
concerned about that,” he declared.
Evans said core PCE inflation will not rise to 1.5% — still a half
percent short of the top end of the Fed’s target range — until sometime
in 2013, but said “if I’m wrong I would change my mind and I would be
thinking about a slightly different monetary policy.”
Another thing the Fed will have to watch is bank lending, which has
only recently begun to grow modestly after a long period of contraction.
Evans said he would welcome faster growth in bank lending but said
that at some point the Fed would need to tighten credit to prevent
excess reserves from flowing into the economy through loan windows too
rapidly. And he said the Fed would need to act somewhat preemptively.
“We can’t wait until all of a sudden you get really strong bank
lending,” he said, because “it takes awhile to curtail it once you get
there.”
He said the Fed needs to have “a baseline outlook for how things
are going to proceed” over the next year or two and then “constantly
assess” the data to see if bank lending and other indicators are
performing as expected or better than expected.
If lending and other aspects of recovery improve more rapidly than
projected by the Fed, then “the plan for exit may need to be
accelerated.”
“That would be good thing,” he said. “It would be an easy and happy
thing to do” because it would mean a more rapid return to economic
health and full employment.
Another indicator the Fed will be watching, he said, is short-term
market interest rates, which he said remain very low now because savings
are exceeding investment. As those rates rise, he said it will be a sign
that “liquidity trap” risks have diminished and that there is less need
for Fed support.
Evans said the FOMC will be revisiting its exit strategy, as it did
a year ago, to determine the preferred method and sequencing of steps
for tightening policy when the time comes. He said the Fed is “feeling
pretty good about” the effectiveness of the tools it has to drain
reserves if necessary when it raises the rate of interest on excess
reserves and other rates.
One early step the FOMC could take, he said, “would be to simply
stop reinvesting” the proceeds of maturing securities and “let the
balance sheet passively go down.”
He said that would have “only a small effect initially,” but would
shrink the balance sheet significantly over time.
As to when the FOMC might stop the reinvestment practice, Evans
indicated he would not favor timing it to coincide with the end of QE2
because it would have the effect of reversing some of the intended
benefits of that program. It would be more appropriate to discontinue
reinvestment “some period of time after we stop” buying assets, he said.
Asked about the Federal Reserve Board’s announcement Thursday that
Fed Chair Ben Bernanke will begin giving press conferences four times a
year, Evans said, “I think the press conference is a very positive
development. I think the Chairman will do a fabulous job just as he does
in Congressional testimony.”
Evans said the press conference “will provide ever-increasing
clarity” on monetary policy and said “the entire package of how we
communicate … will be enhanced greatly.”
He said he does not expect the press conferences to diminish the
importance of the FOMC minutes, which are released three weeks after
meetings.
“Giving the Chairman the opportunity to speak for the Committee on
recent developments beyond five paragraphs will be helpful,” he added.
Evans downplayed the longer term impact of the disaster in Japan,
tumult in the Middle East and other external shocks, saying he does “not
think it will leave a big imprint on our economic trajectory.”
He added, however, that there are “a lot of uncertainties.”
In wake of a Supreme Court ruling that the Fed will have to release
detailed information on its discount window borrowers, Evans said the
Fed had encouraged troubled firms to borrow from the Fed and said
confidentiality helped “remove the stigma” of going to the window.
He suggested that the loss of conditionality could add to that
stigma but said “we’ll have to implement policy the best way we possibly
can.”
The ruling might make “an argument” for reviving the crisis-era
Term Auction Facility (TAF), which enabled firms to get shorter term
credit from the Fed with greater anonymity.
** Market News International Washington Bureau: 202-371-2121 **
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