–Wants Rate Above 3% ‘Reasonably Quickly’ as GDP, Jobs on Steady Path

By Brai Odion-Esene

WASHINGTON (MNI) – Kansas City Federal Reserve Bank President
Thomas Hoenig Thursday made the case for the central bank hiking its
target rate to 1% by the end of the summer, and then raising it at a
“reasonably” fast pace to above 3% on confidence that the economy and
jobs are on a steady path toward potential.

The process of raising the fed funds rate “should begin sooner to
avoid the danger of having to over compensate later, as so often happens
in policy,” Hoenig said in a speech prepared for delivery to a forum
hosted by the Bartlesville Chamber of Commerce.

This would serve to reduce the chance of a build-up of new
financial imbalances, he said.

The Fed would first of all have to continue the wind down of the
extraordinary support it gave to the financial sector during the
financial crisis, and eliminate its committment to keeping rates
exceptionally low for an extended period of time, Hoenig said.

With this done, “the FOMC would be prepared to raise the funds rate
target to 1% by the end of summer,” he said, after which the Fed would
maintain rates at that level so it could judge if and to what degree
“further policy adjustments are warranted to assure long-run financial
equilibrium and stability.”

Hoenig said he is sure the U.S. economy will be able to deal with
the increase in the funds rate, because a 1% target, coupled with the
Fed’s large balance sheet, still provides an extraordinarily
accommodative monetary policy environment and one that would ensure the
economy’s continued progress in the recovery.

In order to fully restore monetary policy to its long-run
equilibrium level, Hoenig said the Federal Open Market Committee should
hike the target rate to above 3% “reasonably quickly as we gain
confidence that GDP and employment are on a steady path toward
potential.”

He added, “The final steps would take rates to between 3.5 and 4.5
percent as economic growth approaches long-run potential.”

On reducing the size of the Fed’s balance sheet back to its
pre-crisis form, Hoenig suggested the process begin when the rate rises
above 1% “or sooner if conditions provide the opportunity.”

And the Fed should not wait until unemployment drops below 9%
before raising rates, he continued, warning that lowering interest rates
is “a blunt instrument that has a wide set of intended but also
unintended consequences.”

That is why the central bank want to return to a sustainable
long-term equilibrium policy rate, starting soon, he said.

Right now, however, Hoenig noted improvements in the labor market,
noting “clear signs that the process of job creation is taking hold.”

Recent data suggest the recovery is broad-based and
self-sustaining, Hoenig said, and may even be stronger than anticipated.

He pointed spending by consumers that is expanding at a solid pace,
and the “sharp rebound” in manufacturing activity. Purchases by
businesses of equipment and software have been “robust,” he added.

Still, growth will be slower this year he cautioned, between 3% to
3.5%.

Construction has yet to “convincingly” improve, he said, predicting
building activity to remain subdued through most of 2010 “or longer.”

As for inflation, Hoenig expects the overall number and the core to
remain around 2% and 1% respectively for the next year or so.

“However, as the economic recovery continues or picks up momentum,
I expect inflation to drift higher,” he said.

The Kansas City Fed president also touched on the ongoing crisis in
Europe, saying the situation “reminds us to be wary.”

Noting the increase in flight to safety — as investors exit risky
assets in favor of U.S. Treasuries — Hoenig said such shifts will have
a negative net effect on U.S. economic growth in the near-term.

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

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