–Sees Greater Risk Of Movement Towards Deflation
–In Favor Of More Explicit Inflation Target
By Brai Odion-Esene
SAVANNAH, Ga. (MNI) – Dennis Lockhart, president of the Atlanta
Federal Reserve, said Monday that while the decision by the Federal
Reserve to inject more monetary stimulus into the economy “is not clear
cut,” the sluggish economy and near zero inflation rate means he is
leaning toward more quantitative easing.
“If something is to be done about the state of the economy,
quantitative easing is the leading option,” Lockhart declared.
In remarks prepared for the Savannah Rotary Club, Lockhart, one
more Fed’s more dovish officials, cautioned that the economic challenges
of the moment “call for careful navigation.”
There are risks accompanying both action and inaction, he said, but
the risks that weigh more heavily on his mind are those associated with
a movement toward deflation.
“I am prepared to consider action in the near term that can help
avoid that danger and change the course of the economy for the better,”
Lockhart said.
And, despite the opinions of many Fed watchers, the decision to
initiate further quantitative easing “is not clear cut,” Lockhart said.
He said policymakers have to weigh the arguments for and against
more QE, potential costs versus benefits, and competing risks.
As for Lockhart, “I am leaning in favor of additional monetary
stimulus while acknowledging the longer-term risks the policy may
present.”
“At this juncture, and given the circumstances of sluggish growth
and measured inflation that is too low, I give greater weight to the
risk of further disinflation leading to deflation,” he said, arguing
that QE2 would serve as a form of risk management — “an insurance
policy that is prudent to put in place at this time.”
In his speech, Lockhart also declared his openness to a move that
he believes would strengthen the effect as well as compensate for
potential risks of more quantitative easing — the adoption of a more
explicit inflation target by the Federal Open Market Committee.
“I believe doing so might serve as a further step to ensure the
anchoring of public expectations about long-term inflation and the
response of the FOMC to adverse price developments,” he argued.
In addition, a more explicit inflation target is something the
public could easily understand, “and would reduce uncertainty at a time
when it is badly needed,” Lockhart said.
Lockhart did note other options available to the Fed, aside from
more QE. Either increasing the availability of credit — but there is no
lack of liquidity in the banking system — or via the dollar exchange
rate — “speculation about QE2 has already caused a drop in the dollar’s
value on exchange markets,” and led to currency war concerns, he said.
Lockhart said he sees scope, at the margin, for further monetary
stimulus to induce households and businesses to overcome their current
spending caution, even while deleveraging.
“A quantitative easing program of scale should have the effect of
making credit cheaper and, if successful in upgrading the outlook, more
available as loan demand rises,” he said.
He did acknowledge, however, the challenge of making a dent in the
high unemployment rate using monetary policy.
Using an argument also made by Minneapolis Federal Reserve
President Narayana Kocherlakota, that the skills of the unemployed often
do not match the jobs available, Lockhart said there is little scope for
monetary policy to have much effect on the “mismatch” between skills and
jobs caused by industrial dislocations and the skill erosion that can be
associated with long-term unemployment.
Uncertainty is another key factor that is constraining job growth
and investment, he said. And uncertainty cannot be dispelled by monetary
policy.
Lockhart noted the performance of the economy so far has been
“disappointing,” with the outlook overall having deteriorated.
“With current inflation running at about 1 percent or a little
higher and with official unemployment measured at 9.6 percent, it’s
clear that the economy is not where we want it to be,” he said.
Looking ahead, the Atlanta Fed president says he expects third
quarter GDP growth to be close to that in the second quarter which came
in at 1.6%. This will be followed by a “modest” increase in the rate of
growth in the fourth quarter and further, and then a still modest,
improvement in 2011.
Inflation remains low in this forecast, he said, but with no
further disinflation, and unemployment comes down very gradually.
Lockhart said the risks in this outlook are more to the downside.
He said the fact that growth is so sluggish and inflation so near zero
presents the possibility of a deflationary situation developing, with
very serious implications for employment.
Deflation can feed on itself, he warned, turning into a
deflationary spiral.
“This possibility is by no means my base case expectation, but I
don’t think it can be blithely dismissed. For now it is a risk, not an
actual developing feature of the economy,” he concluded.
** Market News International **
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