By Steven K. Beckner

CHICAGO (MNI) – Chicago Federal Reserve Bank President Charles
Evans gave no indication Thursday that he is ready to tighten monetary
policy.

Evans, a voting member of the Fed’s policymaking Federal Open
Market Committee this year, said “substantial accommodation” remains
“appropriate” given large “resource gaps” and the likelihood that
inflation will be, if anything, “too low.”

Evans said he is prepared to change his forecast and his policy
prescription in favor of a tighter monetary stance if GDP and job growth
prove stronger than expected and if stronger-than-expected wage/price
pressures emerge. But for now, he said, there is “significant resource
slack” that is apt to last “for some time” and commodity price pressures
on broad inflation are likely to recede.

The conditions for accelerating inflation do not exist, he said,
noting that high unemployment is keeping wage gains — the largest
component of business costs — “modest.”

Far from generating higher underlying inflation, he suggested that
high gasoline prices are more likely to be a restraining influence on
consumer spending and in turn GDP growth.

Should this picture change — in particular if higher inflation
expectations were to increase the rate of inflation — he predicted the
FOMC would “act accordingly.”

“Slow progress in closing resource gaps and a medium-term outlook
for inflation that is too low lead me to conclude that substantial
policy accommodation continues to be appropriate,” Evans said in remarks
prepared for delivery to the AFP Global Corporate Treasurers Forum.

Evans said “this accommodative policy will foster a return of
economic conditions consistent with our dual mandate”

He pointed out that the Fed is providing accommodation both by
keeping the federal funds rate very low “for an extended period” and by
asset purchases. He said the latter are not only “aimed at directly
influencing longer-maturity interest rates” but “also play an important
and useful communications role — they signal our commitment to keep
short-term rates low for an extended period of time.”

Evans said “monetary policy evolves as economic circumstances
change” and said “it is vital that we evaluate the impact of new
information on our forecasts and reassess the stance of monetary policy
as circumstances warrant.”

“Contemplating such adjustments in advance will help prepare us for
the eventual time when a change in the stance of monetary policy will be
necessary,” he said.

However, he added, “despite recent improvements to the outlook, we
are not yet at that point”

When the time for tightening does arrive, he said “communication
and transparency will be even more essential.”

Evans prefaced those comments with lengthy comments on economic and
financial conditions and prospects, which supported his view that it’s
premature to begin raising rates or shrinking the balance sheet.

He said the economy is “on firmer footing” and that “there are many
reasons to be optimistic.” He cited more rapid job growth, stronger
business balance sheets, greater availability of credit and strong
manufacturing.

But he said that the continued “accommodative” stance of monetary
policy is helping underpin this growth and said that “continues to be
warranted” because “areas of weakness remain.” He cited “very depressed”
residential and commercial real estate markets, still “limited” access
to credit, state and local government spending cuts and the drag from
high energy prices, as well as the impact of Japan’s natural disasters.

Evans projected 3.75% real GDP growth over the next two years, but
said that pace is “too low to generate swift relief in the labor
market.” Such growth could reduce the unemployment rate by “roughly
three-quarters of a percentage point a year” but at that rate he said
“it could take quite some time for the unemployment rate to return to
the 5.25% to 5.50% range that most FOMC participants see as being
consistent with our dual mandate in the long run.”

“Indeed, my colleagues project the unemployment rate will still be
relatively high, in the range of 6.8% to 7.2% at the end of 2013,” he
added.

Evans acknowledged that the rise in gasoline prices, until
recently, had pushed up headline inflation, but said “it is a mistake to
point to an extraordinary rise in the price of any particular good —
such as gasoline — and extrapolate that price increase as having
broader inflationary relevance.”

He said “such relative price movements could evolve into sustained
price increases for a broader base of goods and services” if they were
sustained, if they are accompanied by rising labor costs and if consumer
demand is “firm enough that firms are able to pass through higher
production costs to consumers.”

But he added, “I don’t think those conditions exist today.
Therefore, I believe the impact of rising commodities prices on
inflation will be limited.”

Evans saw “very little evidence of petroleum price increases
foretelling inflation” and said “oil price increases are just as likely
to be followed by lower core inflation in the coming year as they are to
be followed by higher inflation.”

What’s more, “commodities only contribute a minor portion to the
total cost of bringing most items to market,” he said. “And for
commodity cost increases to influence consumer prices, firms must be
able to pass cost increases on to customers”

Besides, labor costs are much more important than raw material
costs for most companies, and given the “substantial slack in labor
markets” and “weak overall labor demand,” he said, “this is translating
into very small increases in wages and salaries…” And productivity
growth is restraining unit labor costs.

“Consequently, we are not seeing upward pressure on prices coming
from labor costs, and modest wage growth may also be a dampening
influence on demand and consumer prices,” he said.

Under his forecasts for output and unemployment, Evans said, “I
expect significant resource slack to remain in the economy for some time
to come, and I also am expecting that slack to exert an important
downward influence on inflationary pressures.”

And so while headline inflation may exceed 2% this year, he said he
does “not see total inflation running very far from core for very long.”
He noted that FOMC participants projected total PCE inflation to fall in
the 2% to 2% to 3/4% range in 2011 and the 1% to 1/2% to 2% range in
2013.

He said his own forecasts are “closer to the bottom of these
ranges.”

But Evans said he is constantly reassessing the outlook and said
“developments that would cause me to change my view would be much
stronger growth in real GDP than predicted in current forecasts, strong
improvements in the labor market, and evidence that wage pressures on
labor costs were starting to build”

“Another thing that would make me reassess my inflation outlook
would be if medium-term inflationary expectations were to rise….,” he
said.

“Right now, professional forecasters’ expectations of long-run
inflation are in the neighborhood of 2%,” he continued, adding “but if
some surprise event were to lead to higher expected inflation,
businesses and households would internalize this new belief and take
actions consistent with it. These actions would, in turn, put actual
inflation on a higher path.”

“If inflation expectations were to start to creep up because of
rising commodity prices or any other factor, the FOMC would consider
this important development and act accordingly to keep inflation
expectations well grounded,” he said.

Recapping, Evans said “current measures of underlying inflation are
subdued and are running lower than what the FOMC judges to be consistent
with long-run price stability.”

“To be sure, we see some increase in headline inflation due to
higher food and energy prices, but we do not expect these to materially
boost underlying inflationary trends,” he said adding that “moreover,
existing resource gaps are still exerting countervailing downward
pressure on inflation.”

“We will continue to pay close attention to the evolution of
inflation and inflation expectations, and we will adjust policy if
developments move our forecast to rates incompatible with our inflation
mandate,” he said.

** Market News International **

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