By David Ryan

MORGANTOWN, W.Va. (MNI) – Richmond Federal Reserve Bank President
Jeffrey Lacker Tuesday night said the Fed needs to be careful not to
allow inflation to accelerate as it uses new and old tools to withdraw
its monetary stimulus.

In his prepared remarks and in answering questions from the
audience, Lacker said the Fed is being careful to get “get behind the
curve on inflation,” and is on the lookout for sudden spikes in oil
prices and other factors.

“I think we need to be a little more vigilant than we were in the
last expansion,” he said, particularly about commodities prices. It’s
easy, he said, to be lulled by futures prices only to find repeated
upward spikes add up to an accelerating inflation rate.

He said the time has not yet arrived for the Fed to be debating
whether to contemplate selling assets like mortgage-backed securities
and he joked the Fed is not engaging in any “secret purchases” that he’s
aware of.

Talking to reporters, Lacker said the most recent favorable
economic data appeared to argue against much more use of the “extended
period” language the FOMC has been using to describe the time until it
raises rates. His comfort level with that language, he said, has been
“diminished,” and he could see dropping it sooner rather than later.

In his prepared remarks, Lacker had warned that Congress must
consider raising taxes or cutting spending and than meanwhile, the Fed
is not going to help out by eroding the government’s debt through
inflation.

In answering questions, he said he admired how Fed Chairman Ben
Bernanke refused to recommend to Congress which choices it should make,
taxes or spending cuts, something his predecessor Alan Greenspan would
at list hint at.

Political pressure in the past, he said, has led to “deleterious
choices,” and “it’s wise for Federal Reserve officials to avoid
recommending” particular combinations of fiscal remedies, to preserve
its political independence.

The government needs to establish limits on the financial
safety net, he said, and the FDIC routinely closes banks while
appropriately protecting depositors with deposit insurance. That needs
to be the case as well with the largest institutions, he said.

Then through some kind of bankruptcy procedure, the FDIC should be
repaid what it spent on insurance payments, he said. The combination of
bankruptcy and the FDIC’s insurance provides certainty when a bank
fails. “The key thing there is letting some institutions fail,” he said.
Lehman’s failure was “instructive,” he said, in that “No one else failed
due to their exposure to Lehman” and the “bulk of the assets were sold.”

Earlier, in his prepared remarks, Lacker said the Fed needs
to withdraw stimulus carefully. Inflation “remains benign” he
said, and the chance of a significant decline in inflation, he
said, has decreased substantially. The U.S., he said, eventually
must raise taxes or reduce spending. The Fed, he added, will not
be increasing inflation to erode the debt.

Lacker said non-residential construction will be a continuing drag
on GDP but improving business investment and consumer spending should
overcome the problems with construction so that the economy continues to
gradually improve.

The latest jobs report, with its 162,000 jobs seasonally adjusted
has been the best sign of recovery so far, Lacker said. Nevertheless,
small business has seen unprecedented damage from this recession despite
the lack of evidence that the banking industry as a whole is impeding
the expansion.

He repeated that clear limits have to be established for
the financial safety net and that proposals for increased taxes
and regulation are creating their own uncertainty in the minds
of business executives.

“In commercial real estate,” Lacker said, “construction is falling, vacancy rates are rising and falling property
prices are eroding owners’ equity positions. No one expects a quick
reversal in either of these negative trends.”

On jobs, “While even the more optimistic forecasters do not expect
rapid growth in employment this year, the labor market does seem to be
lifting itself off the floor now.”

“Putting the whole picture together,” Lacker said, “I think the
most likely outcome for the rest of 2010 is that the national economy
will grow at a moderate rate — consumers spending will gradually pick
up pace and businesses will continue to expand outlays for equipment and
software, and these key components of demand should overcome any drag
from commercial construction or state and local government spending.”

Lacker said that to keep inflation contained, “We will need to be
careful about when and how to withdraw the considerable monetary policy
stimulus now in place.” This time around the Fed will have not only the
federal funds rate but the ability to raise interest rates on reserves
or drain reserve balances “or both.”

** Market News International **

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