NEW YORK – Based on his predictions of core PCE inflation rising slowly this year, and remaining under 2%, a “modest” rate hike by the end of the year “would be desirable,” Federal Reserve Bank of Minneapolis President Narayana Kocherlakota repeated Wednesday.
Should PCE core inflation rise to 1.5%, a hike of 50 basis points would be called for, Kocherlakota told the Forecasters’ Club of New York, according to prepared text released by the Fed, echoing remarks he made last week.
“Of course, a core inflation rate of 1.5% is still markedly below the Fed’s price stability objective of 2%,” he said. “Accordingly, an increase of 50 basis points in the fed funds rate would still leave the Fed in a highly accommodative stance. First, the fed funds rate would be extremely low—between 50 and 75 basis points. As well, the Fed’s holdings of long-term assets would continue to provide significant accommodation.”
Of course, monetary policy would not be as easy as it was in 2010.
“Thus, under my baseline forecast, it would be desirable for the FOMC to raise the fed funds target interest rate by a modest amount toward the end of 2011,” Kocherlakota said. He noted that the FOMC could choose instead to shrink the Fed’s balance sheet instead by stopping reinvesting principal payments from its securities holdings into long-term Treasuries, or by selling some long-term assets.
Kocherlakota said he prefers using the fed funds target interest rate to adjust policy. “I have more confidence in that instrument of policy, based on our many years of experience with it. I suspect that this confidence is shared by the public at large.” He said shrinking the balance sheet is “a longer-term mission that can take place over the next five or six years or so.”
He noted that his predictions can be off, in which case, “If core PCE inflation were to fall over the course of 2011 relative to 2010, then it would be desirable for the FOMC to ease further in response to that decline. I imagine that easing would take place through the purchase of more long-term government securities.
“On the other hand, my forecast for core PCE inflation might be too low. For example, core PCE inflation might rise to 1.8% over the course of 2011. The FOMC should respond to evidence of such a large increase by raising the target fed funds rate even more aggressively than I have suggested. I would recommend raising the target fed funds interest rate shortly thereafter.”
