By Steven K. Beckner

DENVER (MNI) – St. Louis Federal Reserve Bank Vice President
William Gavin said Sunday that the U.S. economy “appears to be in a trap
today” with short-term interest rates near their zero bound.

Gavin said that, because of this, “unemployment is going to stay
high for a long time,” possibly “two or three years” — in a
presentation at the National Association for Business Economics’ annual
convention.

Although some have said that additional quantitative easing would
be successful if it lowers long-term interest rates, Gavin said “any
liquidity effect” of Q.E. would be “transitory” or “short-lived.”

The veteran monetary economist, one of St. Louis Fed President
James Bullard’s advisors, said renewed Q.E. would only be successful to
the extent that it affects inflationary expectations.

Gavin suggested that the Fed Board’s approach to setting rates in
recent years pre-destined the economy to reach the zero bound because of
its heavy emphasis on the “output gap” — the difference between actual
and potential GDP growth.

He maintained that the Fed would do better to make more of a
commitment to a long-run inflation target — or possibly a price level
target.

Gavin said the so-called “Taylor Rule” model which the Fed Board
now uses is “prone to hitting the zero bound” because of, 1) the Fed’s
statutory dual mandate to maximize employment while maintaining price
stability, and 2) because it has no explicit inflation target.

The Fed is unlikely to get free of the dual mandate, he said, but
if it had a stronger inflation target he said it would stand a better
chance of avoiding the zero bound in the future.

Gavin said no central bank can hope to hit a short-run inflation
target of, say 2%, each quarter, but said “that’s not the same as saying
you shouldn’t be clear about where you want to go in the long run.”

With a price path or price level objective, he said that if prices
rise too little or too much in one year, the Fed could make up for it
the following year.

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

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