FOMC speech

Federal Reserve Bank of Atlanta President and CEO Dennis P. Lockhart is a non-voting member of the FOMC in 2010. Yesterday he gave a speech to the Downtown Atlanta Rotary that I felt contained some valuable insight into the current thinking of some FOMC members. Below are some quotes from his speech with my thoughts afterward.

2010 outlook
I expect the recent growth of the economy to be sustained, but the pace of the expansion to be slow over the foreseeable horizon. This forecast of slow recovery takes account of nagging problems, particularly unemployment and commercial real estate. Near-term growth will probably not be strong enough to substantially bring down the large number of unemployed.

To back this up, growth at the economy’s long-term trend rate—something like 3 percent annually or a little lower—would generate about 160,000 jobs per month under standard assumptions about population growth, labor force participation, and productivity trends. Employment growth at this level would reduce unemployment only marginally over the coming year. As Friday’s payroll employment report indicates, getting to 160,000 jobs per month could be a challenge even with GDP growing.

As regards the inflation outlook, I am reasonably confident that the rate of inflation will remain in check for the immediate future. Current inflation readings are acceptable and inflation expectations seem to be stable. I talk to many business people who tell me they have little or no pricing power. On balance, I expect inflation pressures to be restrained as a slow recovery proceeds.

In sum, I expect a better overall year in 2010. The bottoming of the inventory liquidation cycle, some recovery in business investment, and better economic prospects in the rest of the world set a foundation for continued growth going forward. But it will not be a gangbuster recovery.

BOB: This view is roughly in line with my own view. Gradual economic recovery as we transition from government stimulus to private demand. The employment situation should also improve as the pace of job losses lessons and job growth resumes. It takes over 100,000 new jobs monthly just to absorb new workers, so it will take many months of strong job growth in order to see the unemployment rate drop significantly. Fortunately, inflation remains a non-issue as excess capacity and weak demand are keeping pricing pressure to a minimum.

Thoughts on exit
If my outlook for 2010 is accurate, this will be the year that necessarily involves exit from a lot of the emergency policies put in place to fight the financial crisis and recession. How that process might unfold is and will be a matter of active discussion among the members of the FOMC.

Last January, I talked about the dramatic expansion of the Fed’s balance sheet in response to the financial crisis in September 2008. Although the total balance sheet has not yet started to shrink, some unwinding already has begun. At our last meeting in December, the FOMC said that most of the Fed’s special liquidity facilities will expire at the end of this month and the purchase of mortgage-backed securities and other agency debt will taper off and come to an end early this year.

A bit like Goldilocks’ porridge, the exit or unwinding process needs to be—in my view—not too fast, not too slow, but just right. I continue to support an interest rate policy described in recent FOMC statements as low for an "extended period." What does "extended period" mean? I don’t want to put a date on it. To me, it means the policy rate will be kept low until recovery has shown momentum that is based on private business and consumer demand, job growth is established or at least imminent, and the downside risks appear to be safely navigable. This unwinding is in the context of well-behaved inflation, of course.

BOB: The exit from the emergency lending facilities has been happening for several months. They were designed to unwind themselves as demand for funds diminished. Closing the programs is a formality – they are no longer needed. The program to purchase mortgages may need to be reinstated at some point. Early indications are the market can support MBS, though higher rates are likely. Still, it was not so long ago that a 6% 30-year fixed-rate mortgage was considered a great rate!

I am concerned that certain legislative proposals could compromise the independence that enables staying on course. I’m referring to the "audit the Fed" amendments that were passed in the House and introduced in the Senate. The audits would be performed by the Government Accountability Office (GAO). In 1978, Congress thought it wise to exempt monetary policy from GAO review. Congress did this in keeping with established international practice and studied opinion that independent central banks do a better job of keeping prices stable. The effect of these proposals would be to roll back the clear exclusion of monetary policy. The Fed has no argument with audits in the conventional meaning of the term. We’re already subject to many audits by the GAO and external auditors. In government, the word "audit" can be misleading sometimes. GAO audits can amount to full-blown policy reviews. Fed operations outside of monetary policy are already subject to GAO policy review, so this proposal is about ad hoc, after-action reviews of monetary policy, potentially frequent. In my view, this notion is not about transparency and accountability. Both are bedrock principles to which the Fed should continue to be held. Rather, this is about politicizing a process that should remain apolitical.

BOB: Anyone that follows the Fed/FOMC closely knows how important independence is to what they do. Auditing their balance sheets is totally appropriate, and has happened for a long time. Auditing their FOMC meetings (which really means publicizing, criticizing, and reviewing) is another. This should not happen. The most confusing part of this idea to me is who in their right mind thinks that Congress could do a better job of monetary policy than the FOMC?  The FOMC should remain private, and I expect they will. 

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