The U.S. Federal Reserve should stick to its super-easy monetary policy to fight unemployment and spur a painstakingly slow economic recovery, even if doing so pushes inflation temporarily higher, a top Fed official said on Wednesday.
There is a natural tendency for policymakers to pull back on accommodation too early before the real rate of interest has fallen to low enough levels, Chicago Fed President Charles Evans said in an address to a business group. It is essential that the Fed clearly commit to a policy action that is measurable against our goals.
Jeffrey Lacker, president of the Richmond Fed and an inflation hawk, also touted the benefits of clear communications in an interview with CNBC.
However, unlike Evans, he said it would not be appropriate for the Fed to set a numerical target for unemployment.
Fed policymakers meeting on Jan 24-25 will debate a statement on their longer-run policy goals and could go so far as to set an inflation target.
Last week, the president of the St. Louis Fed Bank, James Bullard, told Bloomberg Radio that agreement to begin inflation targeting was near. We are getting closer to being able to make a committee-wide statement about these longer-term policy issues, he said.
Evans wants the central bank to keep interest rates near zero until either unemployment falls below 7 percent or inflation rises above 3 percent. He said that a prolonged period of low rates will likely help the economy and is unlikely to result in higher-than-normal inflation.
Unemployment registered 8.5 percent in December. Despite a recent improvement in economic growth, Evans said, inflation will probably fall to 1.8 percent this year and to near 1.5 percent in 2013 and 2014, below the 2 percent level the Fed views as healthy.
Lacker said he was not too worried that inflation would exceed the Fed's comfort range this year.
Evans said that inflation at around two percent seemed to be tolerable to a majority of policymakers currently but added: I think clarifying that would be very helpful.
He said that, given current soft economic conditions, an agreement on fiscal policy between Congress and the White House would be reassuring. It would be helpful to have more stimulus, Evans added.
Meanwhile, the risk that Europe's debt crisis could disrupt the U.S. financial system is looming larger, he said.
Three percent inflation is a risk that we should be willing to take given the dire consequences of doing too little to help the economy, Evans said.
Fed officials are at odds on what the economy needs, with some like Evans calling for easier monetary policy and others, including Lacker, warning that more stimulus would be ineffective at best and at worst spark inflation.
Atlanta Fed Bank President Dennis Lockhart, also speaking on Wednesday, noted that the housing market, which has weighed heavily on the economy, remains depressed. He said housing prices were still falling year-over-year, suggesting the troubled sector has yet to see a bottom.
Lacker singled out money market funds as being particularly susceptible to financial market shocks.
The major vulnerability of our financial system to Europe has to do with money market funds. We haven't fixed the structural problems there and until we do they're vulnerable to flights, Lacker said.
The Fed has kept interest rates near zero for more than three years and has signaled it will keep them there until at least mid-2013. This month it will start publishing short-term interest-rate forecasts, a move that is likely to push expectations for a rate hike even further into the future.
Both Evans and Lacker said they strongly supported the Fed's decision to publicize rate forecasts. Evans said the move will help the economy by reducing uncertainty.
Households and businesses will be able to make better-informed decisions if they have a clearer notion of future policy rates, Evans said. The potential for reduced uncertainty could also lower the risk premium embedded in longer-term interest rates.
(Writing by Ann Saphir and Pedro da Costa; Editing by Andrea Ricci)