NEW YORK – While recent economic indicators provided much good news, it could be “several year” before the economy rebounds completely from the recession, Federal Reserve Bank of Richmond President Jeffrey M. Lacker said today.
Specifically, Lacker said, the labor market will need time. After the loss of 8.4 million jobs, “That has raised the prospect of another jobless recovery such as the one that followed the 2001 recession, where employment fell for a 21-month period after the official end of the recession. This time, though, I think that employment is already on the path to steady growth, he told the Virginia International Investors Forum, according to prepared text of his remarks, which were released by the Fed.
Turning to inflation, Lacker said there have been “several unwelcome instances over the last decade of energy price surges spilling over into core inflation. This pattern suggests that monetary policymakers might need to reconsider the strategy of treating energy price gains as by-gones if the futures curve is flat. Given the broad upward trend in energy prices over the last decade, responding more aggressively would have kept overall inflation lower and closer to a rate I view as ideal.”
However, the public expects inflation to rise faster than the 1.8% rate posted in the past half-year (1.1% at the core), with most surveys finding expectations of 2.9% inflation. “These readings on inflation expectations have been persistently high, and that's troubling,” he said, “since they raise the possibility that people think the FOMC will be unable or unwilling to conduct monetary policy in a way that keeps inflation from rising significantly during this recovery.”
This, of course, makes setting monetary policy “challenging” at best. “Current policy settings are still at emergency levels, with the federal funds rate near zero and with our balance sheet 2 ½ times the size it was three years ago. These settings are currently providing substantial monetary stimulus. As a technical matter, whenever we decide to begin normalizing policy it will be straightforward to sell assets, shrink our balance sheet, and raise the level of short-term interest rates. The difficulty, of course, is that no one wants to tighten policy prematurely and needlessly dampen the recovery. So recognizing the right time to begin normalizing our monetary policy settings is going to be hard, and reasonable people can differ about this,” Lacker said.
“For my part, I will be looking for the time at which economic growth is strong enough and well-enough established to warrant raising our policy rate. It may make sense, however, to begin normalizing our balance sheet in advance of raising rates,” he said. Normalizing our balance sheet means reducing its size, but also returning to our traditional Treasury-only asset holdings. My worry is that we will let the obvious slack in the economy lull us into a false sense of security regarding inflation, which could allow inflation pressures to build before we raise rates. That happened in 2004 and it could happen again, so we at the Fed will need to be careful to avoid waiting too long to raise rates.”
Lacker said he is also concerned about the federal budget deficit. “In broad terms, we all know what needs to be done — cut spending or raise taxes. If we don't, an adverse sequence of events will be set in train: investors will be increasingly reluctant to hold more Treasury securities, yields will consequently rise significantly, the cost of capital will increase for firms producing in the United States, capital formation will suffer, productivity growth will slow, and thus real household incomes will stagnate. In short, the well-being of future generations is at stake. My hope is that policymakers will find a way to move fairly quickly to make the adjustments needed to put the budget on a sustainable path. The sooner we make the necessary adjustments, the longer the period over which we can spread out the adjustment cost, and the more likely we are to avoid a fiscal crisis of the type Greece is now experiencing.”
