–US Can Weather Mild Recession in Europe

WASHINGTON (MNI) – Richmond Federal Reserve President Jeffrey
Lacker said Wednesday the drags on U.S. economic activity are turning
out to be more serious than initially anticipated, leading to his
expectation that growth will not exceed 2.5% in 2012.

“Some of the more persistent headwinds the economy is facing are
more serious than we thought,” Lacker said in an interview on CNBC.

He said these include the labor market mismatch, the pall cast over
investment decisions by a range policy issues “that keep people a little
uncertain, a little hesitant about investing and making outlays,” and
then the housing market being “flat on its back.”

Lacker forecasts economic growth in 2012 to come in between 2.0%
and 2.5%, which he said “Seems like a good guess to me,” adding that it
is in line with many other forecasts.

The sovereign debt crisis in Europe is a “reasonably serious”
threat to this forecast, but that “I think we can handle it pretty
well,” he said, adding, “I don’t think it’s going to push us into
recession.”

A mild recession in Europe will cut into U.S. export growth,
causing economic activity in the first half of 2012 to be “a little
softer” compared to the second half, “But it looks like we can weather
it,” he said.

Lacker said an upside to his forecasts is the U.S. consumer.
Confidence is gradually firming as balance sheet situations steadily
improve.

The Fed reported Monday that U.S. consumer credit rose by $20.4
billion in November, the biggest gain since November 2001. Calling the
report “particularly striking,” Lacker said if those trends are
sustained — as opposed to being a temporary blip — “I think we could
get a stronger consumer next year than we expect.”

Asked for his reaction to the drop in the unemployment rate in the
last two months — to 8.5% in December — Lacker said he believes
progress will be made in lowering the jobless rate, “but it’s likely to
be slow.”

Labor participation is hard to forecast, he said. “We are seeing a
decline in participation that’s in part secular and in part cyclical and
teasing out those two is really hard right now.”

These are issues that Lacker argued cannot be impacted by
additional policy actions from the Federal Reserve.

“The Fed does not control growth,” he said. “We can interfere with
it, we can impede it but in general the growth rate the economy can
crank out is determined by technology, people’s preferences, resource
endowments, other policies and the like.

“Our job is to keep inflation low and stable,” he added.

As a result, Lacker said he doubts quantitative easing by the Fed
could bring the unemployment rate down on a sustained basis. Monetary
policy definitely has an effect on inflation, but any increase in growth
would only be temporary.

Lacker said the U.S. is heading towards an inflation rate of about
2% for the coming year. He said he is not concerned about inflation
rising past the Fed’s target rate this year, noting that expectations
seem to be well anchored.

He warned that there are some risks to that outlook, however, as
sizable commodity price shock “that looks to be pretty persistent could
throw that off, could pass through to core if we don’t respond
appropriately.”

In the minutes from the December meeting of its policymaking body,
the Federal Open Market Committee, the Fed announced it will begin
publish members’ projections of the future path of interest rates, along
with their quarterly economic forecasts.

Lacker said the projections will vary across the committee and
provide a picture of the divergence of participants views about what the
appropriate policy path looks like going forward.

“The thing to remember is that it is a forecast, not a commitment,”
he stressed, and policy is contingent on incoming economic data, which
could change the forecast paths and result in a different outcome.

Asked how this affects the FOMC’s promise to keep interest rates
low for an extended period until at least mid-2013, Lacker said there
has been “discussion and debate” within the FOMC about whether there is
a way to improve on how forward guidance is provided.

Questioned about the white Paper on housing published by the Fed,
Lacker said he was not so sure about some of the proposals made in the
document, and warned against the central bank becoming involved in
matters outside of monetary policy.

“When the central bank strays into fiscal policy it get itself
entangled in politics and that can threaten our independence,” he said.

** Market News International Washington Bureau: 202-371-2121 **

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