RTTNews - New York Federal Reserve Bank President William Dudley said Wednesday that economic contraction was slowing down and predicted that there will be moderate growth in the second half of 2009.

Speaking at the Association for a Better New York breakfast meeting in New York City, Dudley said that he believed that the economy would be boosted by modest recoveries in housing activity and automobile sales, the impact of the stimulus package on domestic demand and a sharp swing in the pace of inventory investment.

He did say, however, that economic recovery would be slower than expected because consumption is likely to grow slowly because of weak income growth and a more gradual decline in the saving rate in regard to consumer spending in the housing market.

Dudley said that the balance of economic risks is still tilted toward weakness in growth and employment and not toward higher inflation, and added that it would be premature to talk about when the Fed will begin to tighten monetary policy.

Dudley stressed that the Fed's expanded balance sheet does not constrain the central bank's ability to exit from the current degree of policy accommodation.

In other words, contrary to what is sometimes argued, it is not the case that our expanded balance sheet will inevitably prove inflationary, he said.

He added, The public must be absolutely confident that the Fed can meet its monetary policy objectives of low and stable inflation and sustainable economic growth.

Echoing a familiar theme in recent speeches by Fed Chairman Ben Bernanke and San Francisco Fed President Janet Yellen, Dudley then addressed concerns that the Fed would have trouble unwinding is vastly expanded balance sheet and said that the central bank could handle the tightening of monetary policy smoothly.

Dudley said that although the Fed has very high excess reserve balances, it still has the ability to pay interest on those reserves and prevent them from creating excessive credit. This also makes the interest of excess reserve rate a risk-free rate and allows the Federal Reserve to raise that rate, which will cause banks to hold their excess reserves with the Fed, instead of lending them out, he explained.

Because banks no longer seek to lend out their excess reserves, there is no increase in the amount of credit outstanding, no redeposit of the excess reserves, no increase in economic activity and no risk that excessive credit creation will fuel an inflationary spiral, he said.

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