Tags: Fed | Kocherlakota | Inflation | Risk | Overblown

Fed's Kocherlakota: Inflation Risk Is Overblown

Thursday, 18 November 2010 03:09 PM

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota defended the central bank’s program to buy $600 billion of bonds, saying criticism it will cause a surge in inflation is misplaced.

“This basic logic isn’t valid in current circumstances,” because banks already have about $1 trillion in excess reserves, Kocherlakota said in the text of remarks in Chicago today. The creation of more reserves through bond purchases won’t be “‘kindling’ for some future inflationary fire,” he said.

Kocherlakota, who will vote on the policy-setting Federal Open Market Committee for the first time next year, said he supported the central bank’s decision to expand monetary stimulus. He called the policy “a move in the right direction,” although “there are good reasons to suspect that the ultimate effects” will be “relatively modest.”

The Minneapolis Fed chief bolstered the central bank’s defense of a policy that has increasingly come under attack since it was announced on Nov. 3, a day after the election gave Republicans control of the House of Representatives. Yesterday, John Boehner, nominated as the next House speaker, and three other Republican lawmakers sent Fed Chairman Ben S. Bernanke a letter expressing “deep concerns” about a policy they said risked weakening the dollar and fueling asset bubbles.

‘Nonverbal Communication’

The “main goal” of quantitative easing is to lower real interest rates, cutting borrowing costs for consumers and companies and bolstering housing and stock prices, Kocherlakota said. He also said the policy is also a form of “nonverbal communication” about the FOMC’s future plans, indicating that the “extended period” of low interest rates it has promised will last “for an even longer period of time.”

Kocherlakota said “inflation and employment are both too low, and the pace of the recovery is too slow. Economic growth is low and softening further.”

“I think it is safe to say that, given this situation, the FOMC would have liked to have been able to cut its target interest rate,” he said. “But this option is not available.”

The Fed has kept its benchmark interest rate near zero since December 2008, which has failed to bring down an unemployment rate that’s held at 9.4 percent or higher since May 2009.

A group of 23 people including former Republican government officials and economists published a letter to Bernanke this week urging him to halt the expansion of monetary stimulus because it risks an inflation surge.

Officials in Germany, China and Brazil have also criticized the U.S. central bank, with German Finance Minister Wolfgang Schaeuble calling the Fed’s asset-purchase program “clueless” and suggesting it’s designed to erode the value of the U.S. dollar.

Concerns Raised

“There has been some concerns raised that by creating $600 billion of reserves, that that somehow represents extreme downward pressure on the dollar,” Kocherlakota said in response to audience questions after his speech. “For the same reasons why” it won’t cause surging inflation, “that effect is likely to be relatively modest.”

The government could use fiscal policy to mimic the impact of a cut in the Fed’s target interest rate, Kocherlakota also said in the speech to the National Tax Association.

The combination of a consumption tax of 1 percent, a labor- income tax cut of 1 percentage point and an investment tax credit implemented in 2011 would have the equivalent impact of a 1 point interest-rate reduction by the central bank, Minneapolis Fed research shows. The consumption tax and labor-income tax change would be undertaken with a one-year delay.

“The analysis demonstrates the remarkable power of public finance in addressing important macroeconomic questions,” Kocherlakota said. “I find the resultant policy to be attractive because it may be able to generate macroeconomic stimulus without increasing the deficit.”

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Federal Reserve Bank of Minneapolis President Narayana Kocherlakota defended the central bank s program to buy $600 billion of bonds, saying criticism it will cause a surge in inflation is misplaced. This basic logic isn t valid in current circumstances, because banks...
Thursday, 18 November 2010 03:09 PM
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