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Fed's Lacker: Time Nearing to Drop Low-Rate Vow

Tuesday, 29 Jun 2010 08:42 AM

A solid U.S. economic recovery might soon enable the U.S. Federal Reserve to drop its promise to keep interest rates low for an "extended period," Richmond Fed President Jeffrey Lacker said on Monday.

In an interview with Reuters, Lacker said that Europe's debt troubles, which have sparked worries about a renewed credit crunch, had not materially affected his outlook for U.S. growth.

He said he was heartened by the commitment of the Group of 20 nations over the weekend to take steps in addressing large fiscal deficits in many of the world's advanced economies.

"The expansion is on track," Lacker said. "Consumer spending continues to expand at a reasonably strong pace given the circumstances. We continue to see strength in business spending on equipment and software. Those are going to bring the economy forward."

He added that despite recent rumblings in credit markets, which have been accompanied by a spike in the cost of interbank borrowing, a larger shock to the U.S. financial system from European banks was improbable.

After suffering its deepest recession since the 1930s, the U.S. economy has been growing for nearly a year, with gross domestic product rising 2.7 percent on an annualized basis in the first quarter. Jobs are still hard to come by, however, with the unemployment rate hovering just below 10 percent.

Asked if such conditions were robust enough to allow the Fed to alter its repeated commitment to keep borrowing costs at exceptionally low levels for an "extended period," Lacker said: "Not now. Maybe soon."

"I'm comfortable with rates low where they are right now," he said. "I think we're entering a period when, every quarter, it's going to be a legitimate question as to whether to raise rates or not."

Kansas City Federal Reserve Bank President Thomas Hoenig has dissented at four straight meetings of Fed policymakers against the central bank's low-rate pledge, and Lacker appeared to moving in his direction.

The Fed slashed overnight borrowing costs close to zero in December 2008 and has held them there since. Some other developed countries, however, have begun to move rates higher, with Australia leading the way last year.

Bank of England Monetary Policy Committee member Andrew Sentance told Reuters on Monday that fiscal austerity measures in Britain did not remove the need for a rate hike.

There have been hawkish rumblings by some members of the European Central Bank, as well.

Dismissing anxiety about the risk of deflation that is now back on the radar screen for financial markets, Lacker, who is not a voter this year on the Fed's policy-setting Federal Open Market Committee, described the threat as minimal.

"The risk of deflation has been a bit overrated," said Lacker, considered one of the Fed's more hawkish members. "Expectations, as best we measure them over that time period, haven't really tailed off or softened the way they would in a deflationary scenario."

The Fed has flagged stable inflation expectations as a key factor in giving it room to keep interest rates near zero.

Lacker welcomed new restrictions that would be put in place on some of the Fed's emergency lending by a financial regulatory overhaul bill hammered out by congressional negotiators on Friday.

He said it was a positive step in reducing the perception that big firms will always get bailed out.

The Richmond Fed chief said the new "resolution authority" the bill would give financial regulators would make investors uncertain about what the government might do if a very large institution were pushed to the brink.

But in the end, the issue of firms perceived to be too big to fail has not been completely addressed, he cautioned.

"My sense of how this legislation, and the resolution authority, is going to work — it doesn't seem like it's going to solve the problem," Lacker said.

"How it's implemented, how policymakers talk about how they intend to implement it is going to be important."

© 2015 Thomson/Reuters. All rights reserved.

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