By Steven K. Beckner

(MNI) – Cleveland Federal Reserve Bank President Sandra Pianalto
Tuesday said she does not expect rapid rises in food and energy prices
to spill over into a broader acceleration of inflation in an economy
that still faces high unemployment and “key risks” to the downside.

Pianalto, in remarks prepared for a University of Akron economic
summit, said inflation will remain under control in part because the
public has confidence that the Fed will keep it that way and said that
the Fed must do its utmost to maintain that credibility.

Pianalto, who backed monetary stimulus measures as a voting member
of the Fed’s policymaking Federal Open Market Committee last year, gave
no indication she would support a firming of monetary policy this year,
suggesting the economy has a long way to go to return to full employment
and saying that inflation will only “gradually” return to 2% — the top
of the FOMC’s implicit target range.

The upsurge in food and energy costs will have only a “transitory”
effect on the overall inflation rate, she predicted.

She said the economy has been recovering, but at “a gradual and
bumpy pace.”

Only recently has the recovery established “a firmer footing,”
according to Pianalto, who said she is now “seeing clearer signs of a
virtuous cycle of growth. Rising incomes and rising profits are
supporting growth in retail sales and business demand, which in turn
fuels more growth in incomes and profits.”

Pianalto said the recovery has been “supported significantly by
strong growth in exports, manufacturing, and business investment in
equipment and software” and she said she expects these sectors to
“continue to expand at strong rates, and this should help sustain a
solid pace of recovery.”

However, she said, continued housing sector weakness is “acting as
a drag on economic growth.” And she called high unemployment “another
lingering problem.”

Pianalto acknowledged that “the employment rolls are gradually
improving,” but she said “to date we’ve only added back 1.3 million
jobs” compared to a loss of nearly 9 million jobs in the recession.

Job losses have hurt both income and wealth, and she said
“recouping these losses will take some time.”

Pianalto projected real GDP growth of a little more than 3% this
year, but was quick to point to “key risks facing the economy,” most
notably “the recent sharp rise in energy costs associated with unrest in
the Middle East and North Africa.”

“If the spike in oil prices is sustained, it will potentially slow
the pace of GDP growth,” she said.

Echoing recent congressional testimony by Fed Chairman Ben
Bernanke, she said “a sustained increase in the price of oil could cause
some people to worry about higher inflation.”

But Pianalto went on to downplay inflation risks.

Answering her own question as to whether spikes in food and energy
will cause “a lasting increase in the rate of inflation,” she said, “I
don’t think they will.”

Explaining why she thinks that, Pianalto observed, “First, large
increases in food or energy prices have often been balanced out over
time by sharp declines.”

“Second, to cause a lasting rise in inflation, the increases in
food or energy prices have to be large enough and persist long enough
that they spill over and cause sustained increases in a wide array of
other consumer prices,” she continued.

“At this point, there is no evidence of broad spillover, but as a
central banker I keep a close eye on this,” she added.

Pianalto said the Cleveland Fed’s “median CPI” index shows that
inflation “remains very low: just 1% over the past year.”

“Based on the behavior of the median CPI, I don’t expect recent
rises in food and energy prices to cause broader inflation,” she
reiterated. “In fact, I expect the underlying trend in broad consumer
prices, which is currently quite low, to rise only gradually toward 2%
by 2013.”

Pianalto said several factors will keep inflation in check, one
being “the continuing slow growth in wages, which helps determine the
cost of producing goods and services and, in turn, the prices set by
firms.”

“Another factor is many retailers’ reluctance to raise prices in
the face of strong competition and soft business conditions,” she said.

Still another inflation restraint is “the public’s expectation that
the Federal Reserve will keep inflation contained.”

“Despite the recent surge in food and energy prices, measures of
longer-run inflation expectations remain below 2%,” she noted.

“The key to stability of long run inflation expectations, of
course, is policy credibility,” she said. “As a member of the FOMC, I
believe it is my responsibility to do everything I can to underscore
confidence in our resolve to maintain price stability.”

** Market News International **

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