By Yali N’Diaye and Alyce Andres

CHICAGO (MNI) – While additional quantitative easing was a “move in
the right direction,” its effects will likely be “relatively modest,”
Minneapolis Federal Reserve Bank President Narayana Kocherlakota said
Thursday.

And given that the fed funds target is already “essentially at
zero,” lowering it — which Kocherlakota would have greatly preferred if
it was possible — is not an option, leading the central banker to turn
to fiscal policy decision makers to boost growth.

Growth definitely needs more stimulus, he suggested in prepared to
the National Tax Association 103rd Annual Conference on Taxation.

Expressing support for the Federal Open Market Committee’s November
policy decision, Kocherlakota said, “Inflation and employment are both
too low, and the pace of recovery is too slow.”

“More troublingly, the inflation rate is drifting downward” and
“More alarmingly, growth has been decelerating,” he said.

Against this backdrop, “I think it is safe to say that, given this
situation, the FOMC would have liked to have been able to cut its target
interest rate,” said Kocherlakota, who will become a voting member next
year.

In the face of constraint on monetary policy — with quantitative
easing likely to have only a “modest” impact while the fed fund rate
cannot be lowered — “I believe it is important to ask if it is possible
to synthesize the effects of a one-year interest rate cut of, say, 100
basis points using fiscal policy tools.”

Asking how fiscal policy can be used “to mimic monetary policy,”
Kocherlakota described a study done by Minneapolis Fed researchers, who
“argue that the essence of an FOMC interest rate cut is that it makes
current consumption cheaper relative to future consumption. With that in
mind, the fiscal authorities can use the time path of consumption taxes
to accomplish this same change in relative prices.”

For Kocherlakota, “That narrow focus” of fiscal policy to “mimic”
monetary policy “seems appropriate.”

“I find the resultant policy to be attractive because it may be
able to generate macroeconomic stimulus without increasing the deficit,”
he also commented.

He described a three-part fiscal policy that would be equivalent to
a 100-basis point interest rate cut.

According to his own estimate, increasing the tax rate on
consumption by 1 percentage point and lowering the income tax by the
same magnitude would add about $20 billion per year to government
revenue from 2012.

Meanwhile, he estimates that an investment tax credit would involve
a one-time cost of $20 billion in 2012.

Quantitative easing, on the other hand, would have only limited
effects on growth.

Still, Kocherlakota did support the FOMC’s November decision, also
arguing it would not feed into future inflation.

“Some observers have expressed concerns that $1 trillion — which
will shortly become over $1.5 trillion — of excess reserves represent
what they term ‘kindling’ for some future inflationary fire,’ he said.
“I believe that these concerns are misplaced.”

He noted that “Banks have nearly $1 trillion of excess reserves.”

“This means that they are not using a lot of their existing
licenses to create money.”

He added, “QE gives them $600 billion of new licenses to create
money, but I do not see why they would suddenly start to use the new
ones if they weren’t using the old ones.”

** Market News International Chicago Bureau: 708-784-1849 **

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