SAN JUAN, PUERTO RICO - New York Federal Reserve Bank President William Dudley said Friday the Fed must make sure rising commodity prices do not cause inflation expectations to become "unmoored" because that would make it "more difficult to keep inflation in check."
However, Dudley gave no indication he sees a need to move up the timing of an exit from the Fed's accommodative monetary policy, saying once again that the economy remains "very far away" from its statutory "dual mandate" objectives and that improvement in economic conditions is "not a reason to reverse course."
Indeed, he said, "faster progress" toward the dual goals of maximum employment and price stability would be "very welcome." He cautioned against becoming "overly optimistic" in a climate of continued domestic weaknesses and "vulnerabilities" at a time of multiple external shocks.
Before he spoke the Labor Department announced modestly better than expected March job figures, showing a 216,000 rise in non-farm payrolls and a further drop in the unemployment rate to 8.8%. But Dudley's reaction was restrained.
The vice chairman of the Fed's policymaking Federal Open Market Committee commented that payroll gains have been "better" the last two months but have been "relatively modest." And he called unemployment still "much too high."
Dudley, in remarks prepared for delivery to an "E-3 Summit of the Americas" hosted by the New York Fed, was speaking amid speculation the Fed may speed up implementation of an "exit strategy" to curb inflation pressures. But nothing he said indicated he is leaning in that direction.
Most of his comments, in fact, were very similar to what he has been saying for some time.
"I am pleased to say that the economic outlook for the mainland has improved in the past six months," he told an audience of Puerto Rican business people. "Despite this, we are still very far away from achieving our dual mandate of maximum sustainable employment and price stability."
"Faster progress toward these objectives would be very welcome," he added.
Dudley said recent data "suggests that we may be much closer to establishing a virtuous circle that will support stronger growth." Hence, he noted, the FOMC upgraded its assessment of the economy on March 15 to say that it is "on a firmer footing."
Turning to the labor market, he took note of the drop in the jobless rate but said, "On the other hand, payroll employment gains have been relatively modest."
He added that "the data on payroll employment for the past two months was better than for the prior months." And "Although there is still uncertainty over the timing and speed of the labor market recovery, I am hopeful that job growth will increase more rapidly in the coming months."
"We would welcome this," he continued. "A substantial pickup is sorely needed. Even if we were to generate growth of 300,000 jobs per month, we would still likely have considerable slack in the labor market at the end of 2012."
But Dudley pointed out that one reason for the economy's improvement is stimulative monetary and fiscal policy and that, therefore, "we at the Federal Reserve have been expecting the economy to strengthen."
"We provided additional monetary policy stimulus via the asset purchase program to help ensure that the recovery regained momentum," he continued. "A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking."
"This is welcome and not a reason to reverse course," he added.
Dudley went on to provide caveats about the brighter outlook.
"(W)e must not be overly optimistic about the growth outlook," he warned. "The coast is not completely clear -- the healing process in the aftermath of the crisis takes time and there are still several areas of vulnerability and weakness."
"In particular, housing activity remains unusually weak and home prices have begun to soften again in many parts of the country," he elaborated. "State and local government finances remain under stress, and this is likely to lead to further spending cuts, tax increases, or job losses in this sector that will offset at least a part of the federal fiscal stimulus."
Dudley also pointed to "several shocks from abroad that could have some impact on the economy's forward momentum," referencing Middle East turmoil and the disaster in Japan.
On a more hopeful note, he said "the most immediate domestic problems may recede rather than become more prevalent." For example, he said faster job growth should lead over time to a sounder housing market.
Turning to inflation, Dudley was cautious but hardly alarmed.
After saying "the risk of deflation is greatly diminished," he acknowledged that both total and core inflation "have increased." But he said they "remain below levels consistent with our dual mandate objectives -- which most members of the FOMC consider to be 2% or a bit less on the personal consumption expenditures measure."
Dudley said "the rise in commodity prices is likely to put further upward pressure on headline inflation in the coming months." But he added, "Provided commodity prices level off around current levels, the effect on inflation should be transitory."
Nevertheless, Dudley said "we will need to ensure that commodity price pressures do not cause inflation expectations to become unmoored."
"If that were to occur, it would be more difficult to keep inflation in check," he said.
Dudley also said the Fed will "need to remain watchful to ensure that low interest rates do not foster a buildup of financial excesses or bubbles that might pose a medium-term risk to both full employment and price stability." And he said the Fed is monitoring interest rates on risky and safer assets" because "an unusual narrowing of these differences could signal that risk is not being appropriately assessed."
However, here too he downplayed the risks, saying, "These differentials for risk on U.S. assets in general do not seem obviously compressed today."
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