NEW YORK - Given the "slow recovery" in the U.S. economy, the Federal Reserve should make "continued measured efforts" to spur GDP and employment growth, but for now these should be confined to using Fed "communication" tools to reassure markets that interest rates will stay low, Atlanta Federal Reserve Bank President Dennis Lockhart said Monday.

A third round of large-scale asset purchases or "quantitative easing" cannot be ruled out, given the "larger than normal risks" posed by the European debt crisis, but QE3 is not appropriate in current circumstances, Lockhart said in Tokyo.

But Lockhart, a voting member of the Fed's policymaking Federal Open Market Committee left no doubt that he would support QE3 if already unsatisfactory economic activity is further depressed by a shock from Europe or elsewhere, especially if inflation falls below the Fed's 2% target.

He harkened back to November 2010, when the FOMC launched the $600 billion QE2 program, recalling that "circumstances at the time were dominated by a falling trend in measured inflation, weakening inflation expectations, and rising probabilities of outright deflation...."

That is not the situation now. Lockhart said he expects "modest growth" over the next few years, coupled with inflation remaining "steady at around 2%."

However, "there are larger-than-normal risks to my outlook," he said. "Chief among them is the potential for broad spillover from Europe to the U.S. and global economy resulting from financial system disruption as well as further economic slowdown."

"For this reason in particular, I currently judge the risks to the U.S. outlook as tilted modestly to the downside," he added in remarks prepared for delivery to the Institute of Regulation & Risk, North Asia.

Even without a worsening of the U.S. economic outlook, Lockhart voiced support for keeping monetary policy highly stimulative.

"We have entered a phase of the recovery in which sustained monetary accommodation is warranted in order to preserve and advance what is still modest progress on employment and economic growth," he said. "Importantly, this modest progress is occurring in the context of what, for me, is acceptable performance with respect to our price stability mandate."

Lockhart said "actions that reinforce the maintenance of policy accommodation are appropriate."

While noting that the Fed's $400 billion "maturity extension program" or "Operation Twist" is scheduled to end on June 30, he did not hint that the program needs to be prolonged, although he did not rule that option out.

Lockhart said he views Operation Twist and the FOMC's "forward guidance" on the near zero federal funds rate "in similar terms." He was referring, in the latter instance, to the FOMC's stated expectation that the funds rate will likely need to stay "exceptionally least through late 2014."

He made clear that FOMC "communication" or "forward guidance" is his favorite tool going forward -- unless the economic and financial situation deteriorates significantly.

"Circumstances today in the United States call for continued measured efforts to quicken the pace of recovery and shrink unemployment, while keeping inflation controlled and close to the FOMC's official target of 2%," he said. "Those efforts for the time being should fall in the realm of communications...."

But the FOMC might have to go beyond communications and resort to more quantitative easing if circumstances take a turn for the worse, he went on to say.

"As popular as it might be in some quarters to rule out further LSAPs (QE3, as it is known), I do not think this option can be taken off the table," he said. "QE3 will work under the right circumstances. But I don't believe such circumstances prevail at this time."

Other Fed policymakers and staffers believe the European crisis could tip the balance toward QE3 if it becomes bad enough that it threatens to undermine an already sluggish recovery and generate excessive disinflation, as MNI reported last week. 

Lockhart prefaced his comments by observing that there may be "limits" to what monetary policy can accomplish.

"(A) lot has been done (by the Fed), yet progress has been quite slow," he said, noting that the Fed has kept the funds rate near zero since December 2008 and has "aggressively expanded the scale of the Fed's balance sheet...."

"In these circumstances, it's natural to ask if monetary policy has reached its practical limits in promoting recovery," he said, suggesting that any central bank is "powerless to cure deep structural problems such as fiscal imbalances or trade imbalances resulting from a lack of competitiveness."

Lockhart added that "central bankers have been wary of trying to compensate for policy constraints in other domains of economic and social policy such as workforce development, tax policy, or currency policy." And he said central bankers must confront "the more immediate and pragmatic consideration of the real or expected effectiveness of current policy and available policy options given the prevailing circumstances in the economy."

Without being specific, he suggested that the Fed and other central banks may have to come up with new methods for achieving their employment and price stability goals.

"The economic conditions of these past few years have required resourcefulness on the part of monetary authorities and evoked unconventional policy actions," he noted. "Central banks, the Fed included, may have to devise ways to respond to unique circumstances in the future...."

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