A top Federal Reserve official on Thursday made a bold call for the U.S. central bank to raise its key interest rate to 1 percent by the end of summer, saying the economy is strong enough to support such a hike.
Thomas Hoenig, president of the Kansas City Federal Reserve Bank, has called for a modest increase in borrowing costs before, but he went further by suggesting it should happen over the next several months and by calling for an increase in borrowing costs to 3 percent in rapid order.
Hoenig, who is known as one of the Fed's most strident anti-inflation hawks, said the U.S. central bank should raise its benchmark federal funds rates to avoid being slow in responding to the recovery.
"Based on the current outlook consensus, it seems reasonable that the economy would be well-positioned to accept this modest increase in the funds rate," Hoenig told a business lunch in Bartlesville, Okla.
The Fed cut interest rates to near zero percent in December 2008 and has kept them there since to aid economic recovery.
Hoenig said the recovery is gaining steam and appears stronger and more broad-based than anticipated.
"We are now seeing clear signs that the process of job creation is taking hold," he said.
Hoenig is a voter on the Fed's policy-setting panel and has dissented against the Fed's exceptionally easy money policies at all three meetings this year. He has said he is worried that rock-bottom borrowing costs for such a long period will fuel another dangerous boom-and-bust cycle.
Hoenig said on Thursday the Fed should start by dropping its promise to hold rates exceptionally low for an extended period, as part of the process of bringing interest rates and the Fed's extension of credit to the economy back to normal.
The U.S. central bank should then raise rates to 1 percent and then stop while it assesses how the economy reacts to the higher rates. If the recovery remains solid, the Fed should push borrowing costs to 3 percent reasonably quickly, he said.
The Fed should also sell some of the mortgage-backed securities it bought as it sought to give the flagging economy an additional boost after it chopped interest rates to near zero, he added.
The debt crisis in Europe is "fluid" and poses a risk to the recovery, Hoenig said.
Earlier in the day, Atlanta Fed President Dennis Lockhart said the U.S. economy is almost strong enough to allow the Fed to begin thinking about raising interest rates.
While he noted unemployment would likely remain elevated for some time, Lockhart said the U.S. central bank should not wait too long before beginning to tighten the reins.
"The time is approaching when it will be appropriate to consider recalibrating interest rate policy. I do not believe that time has yet arrived," Lockhart said in the prepared text of a speech in Atlanta.
Lockhart's comments mark a significant change in tone for the regional Fed president, who has been among the most dovish on the central bank's policy in recent months.
They suggest firmer growth in the United States is catching the attention of Fed policymakers, despite the renewed risks to the outlook from the turmoil surrounding European debt markets.
"Consumer activity over the last few months has exceeded the expectations of analysts," said Lockhart, who is not a voting member this year on the Fed's policysetting Federal Open Market Committee.
Lockhart sees the unemployment rate, which currently is hovering just below 10 percent, receding only gradually. But that does not mean official borrowing costs can stay near zero indefinitely.
"I'm very concerned about unemployment, and certainly employment trends should be a critical consideration in setting policy," he said. "But I accept that good policy, even in circumstances of unacceptable levels of unemployment, may incorporate higher interest rates."
This view moves him closer to Hoenig, who has been saying for months that the Fed's vow to keep interest rates low for an "extended period" might be counterproductive.
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