The U.S. economy, stuck in one of the worst recessions in decades, can start to recover this year, a top Federal Reserve official said on Thursday.
Jeffrey Lacker, president of the Richmond Federal Reserve, forecast positive growth by the end of the year, despite a lot of uncertainty around the outlook.
A sense that the drop in discretionary spending has run out of steam could give people some confidence that we've almost seen the worst of it, Lacker said on CNBC television.
The large economic stimulus plan enacted by the Obama administration will help at the margin, promoting a stronger recovery than might otherwise be the case, he added.
Lacker, a voting member of the Federal Open Market Committee in 2009, also questioned the conventional wisdom that jammed-up credit markets are dragging down the economy -- saying that instead, the economy is hurting the markets.
Causality can flow both ways. When the economy weakens, it has a big impact on credit markets and financial institutions, he said.
A second FOMC voter said that a rebound would likely be slow as Americans turn to saving after the credit-gorged consumer spending that propelled growth for years.
The recovery, based on consumption at least, will be gradual, Atlanta Fed President Dennis Lockhart said while answering questions after a speech at Kennesaw State University's economic outlook conference in Atlanta.
GOING AGAINST THE GRAIN
Lacker repeated his qualms about the Fed's current approach to healing the economy by targeting specific parts of the credit market.
In January, Lacker was the only member to dissent from the FOMC's current policy of pursuing targeted credit programs, saying he would prefer to expand the Fed's monetary base by purchasing U.S. Treasury securities, which could be a more neutral way to lower market interest rates.
When you target segments (of the credit markets) rather than taking a broad approach, it means higher rates in other market segments, he said.
Echoing comments from earlier this week, Lacker said the Fed must be left to make decisions on the size of its balance sheet, and on the possible sunset of some of its various initiatives, without political interference.
The risk we don't want to run is that people become afraid that we might abruptly terminate a credit program when we needed to, he said.
REGULATORY GAPS AND MORAL HAZARD
On Capitol Hill on Thursday, Fed Vice Chairman Donald Kohn admitted to huge gaps in regulation of insurance company American International Group Inc
No one was minding the whole company and looking at how things interacted, and whether the whole company would, under some circumstances, put the financial system at risk, Kohn told a Senate Banking Committee hearing.
Fed Chairman Ben Bernanke this week displayed a rare flash of anger at the way the risky behavior in some units of AIG put taxpayers on the hook.
While not addressing AIG specifically, Lacker lamented the turn of events that has forced repeated interventions into financial firms deemed too big to fail.
We had a system where we were understood to be backstopping a certain part of the financial system. Now people are likely to believe that we're going to backstop a larger part ... we have to straighten that out.
On a day when the stock of Citigroup
If we have to take the step of exercising control, it should be very temporary, he said. The banks are clearly best off remaining in the private sector.
Lacker said a resurgent banking system was contingent on solving the debt overhang problem plaguing balance sheets.
Private equity is now discouraged because of the prospect of future government injections, so we need to get through that, he said. The way to do that is do what we can to lift those risks off of all banks' balance sheets and get them into a well-capitalized situation.
(Additional reporting by Matthew Bigg in Atlanta, Pedro Nicolaci da Costa and Kristina Cooke in New York, and Karey Wutkowski in Washington; Editing by Jan Paschal)