Resource use that is “quite low,” subdued inflation, and credit restraints that will likely “constrain the speed of recovery” combine to make it likely the Fed will keep rates low for “an extended period,” Federal Reserve Board vice chairman Donald L. Kohn told the Cato Institute’s Shadow Open Market Committee yesterday.

“Although economic conditions have apparently begun to improve — partly in response to the extraordinary steps the Federal Reserve and other authorities have taken — resource utilization is quite low, inflation is subdued, and continuing restraints on credit are likely to constrain the speed of recovery,” Kohn said, according to a prepared text of his remarks released by the Fed.

“For that reason, as the FOMC stated last week, exceptionally low interest rates are likely to be warranted for an extended period,” he continued. “Given the highly unusual economic and financial circumstances, judging when the time is appropriate to remove policy accommodation and then calibrating that removal will be challenging. Still, we need to be ready to take the necessary actions when the time comes, and we will be.”

Removing accommodation will be done when needed “to preserve price stability as the economy returns to higher levels of resource utilization” and will be done on forecasts of economic health rather than current conditions, Kohn stressed in his remarks.

“So we must begin to withdraw accommodation well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability,” Kohn said.

Unable to list “variables that will trigger an exit,” Kohn said he “can’t predict how rapidly we will have to raise short-term interest rates from around zero or remove other forms of accommodation; that too depends on how the economy seems to be recovering and the outlook for inflation.”

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