By Denny Gulino

WASHINGTON (MNI) – Richmond Federal Reserve Bank President Jeffrey
Lacker Tuesday said the Fed will be following its mandate for maximum
employment even if it raises rates next year while the unemployment rate
is above 7%.

“I think it’s a misconception to think we’ve got to get
unemployment all the way down to 5 (percent) or some number like that or
near it before we raise rates,” Lacker said.

Interviewed on C-SPAN, Lacker said that when the Fed eventually
raises interest rates — which he thinks will be necessary next year,
not in 2014 — the unemployment rate “could well be above 7%. I think
we have to prepare for that.”

While maximum employment is not a 7% unemployment rate, the goal of
a lower rate has to be calibrated to the extent of recovery, he said.

“The thing about maximum employment, it’s important to be clear
about what time frame you’re talking about,” and so “maximum employment
for the third quarter of this year probably doesn’t correspond to 6%
unemployment or 7% unemployment.”

“I don’t think it’s feasible for us to get there” that fast, he
said. “So I don’t think we should count as our goal getting unemployment
to 6% in the third quarter and I don’t think we should be measured in
that sense against that kind of standard.”

In fact, the unemployment rate is not the kind of target the Fed
can hit accurately using monetary policy, said Lacker, who has dissented
at all three of this year’s FOMC meetings, most recently last week when
he was the lone dissenter.

On where unemployment converges in the long run, “The consensus on
the long-run policy statement,” released in January, “is very clear on
this: we can’t settle on one target because that kind of thing is really
governed by the real factors that push growth around one way or
another.”

The unemployment rate is influenced by “demographics, productivity
and things like that, and in addition things like unemployment benefit
policy,” he said.

“I think our best contribution to growth, our best contribution to
maximum employment is to provide for monetary stability, provide a low
and stable inflation rate,” he said. “We’ve announced that 2% is what we
interpret as price stability, as a workable definition of the right kind
of price stability we need and I think that’s the best way to keep
unemployment on a good track.”

What the Fed should be looking at, he said, is the growth rate, not
the unemployment rate, “because when growth rates rise the real interest
rate needs to rise and if we lag behind that we’re going to create too
much money and it’s going to be too inflationary.”

Lacker said he sees more growth arriving faster than the average of
his Federal Open Market Committee colleagues’ projections updated last
week. The published growth consensus was up for this year and down a
little later on. “I sort of edged up a couple of tenths across the
board,” he said.

“Manufacturing’s been very healthy, exports — the prospects there
are very strong,” he said. “Business investment has been just fantastic
in this recovery. Maybe it’s slowed down a little in the first quarter
but I see further momentum there. Consumer confidence is gradually
healing as their balance sheets are coming back into line.

“I think we’re going to see continued net jobs growth this year and
next. It’s going to be slow compared to some past recoveries,” he said.

“The healing of the labor market’s been limited by a very real
sense of skill mismatch,” Lacker said. “The mismatch of skills between
workers and vacancies is not an absolute thing, it doesn’t mean it’s
impossible. It just means it’s costly, involves training, involves time,
search to connect workers with vacancies for which they’re a good
match.”

So far, first quarter economic statistics have been encouraging, he
said, despite a preliminary GDP of only 2.2%. He sees “A heartening
signal for consumers, that not only are they willing to increase
spending at a faster pace than in previous quarters, but the composition
— so much on big-ticket items like automobiles — suggests their
confidence in the sustainability of this recovery has grown.”

“For sure it’s not a gangbusters recovery by historical standards
and there are good reasons for that,” he said, “and I think there’s good
reasons to think its about all we can reasonably expect.”

He repeated the FOMC statement about exceptionally low interest
rates through at least late 2014 “is not a pledge, not a promise, it’s
certainly not non-contingent.”

“The language is ‘currently expects’ so this is the Committee’s
anticipation of how their behavior in the future is going to lead
interest rates to unfold,” he said. But what the Committee actually does
“is going to depend how the data comes in, how the outlook evolves.”

He said his own conclusion is that mid-2013 “is sort of the central
tendency of my sense of when we’re likely to need to raise rates to keep
inflation pressures from rising.” And so Lacker has dissented three
times. “I figured if I don’t agree with that sentence I should dissent.”

The Fed’s eventual exit from its exceptionally accommodative
policy, whenever it occurs, may not be as smooth as envisioned, he said.

“I don’t think it’s going to be an easy transition,” he said. “This
is the most challenging time of the business cycle for a lot of central
banks.”

He said Alan Greenspan led the Fed “in raising rates before
inflation actually rose substantially and I think that set a precedent
of preemption of inflation pressures.”

That kind of approach led inflation to average around 2% since the
early ’90s, “a signal achievement,” he said. After 18 years of “very
good price stability” it should be clear the Fed has to act “before you
see (price pressures) emerge, before you see inflation move up
steadily.”

The Fed, he says, is assumed to have “entirely too much capacity to
influence the course of real growth and labor market outcomes.” The end
of the housing market boom shocked the economy and caused the recession,
and it wasn’t the fault of monetary policy, he said.

“This recovery has been the story of the process of our economy
reallocating resources away from the industries that declined and toward
the industries where growth is warranted,” he said. The expansion should
not be expected to be “the mirror image of the contraction that
preceded.”

“For us to provide more monetary stimulus at this point would
likely raise inflation risks and not likely do much for growth,” Lacker
said.

On the banking industry and the markets, Lacker said, “I think we
have a competitive banking system but I wouldn’t describe our financial
markets as driven by competitive market discipline as they could be.”

“About 60% of the liabilities of the financial sector in the United
States are guaranteed either implicitly or explicitly by the U.S.
government,” he said. “Chasing that implicit safety net with more
regulation is not a healthy course. I think we ought to be focusing on
restoring more market discipline and more resilience that comes from
competitive markets.”

Lacker said the “living wills” required of large banks by
Dodd-Frank was a good development. In addition, policymakers should be
less reluctant to use the bankruptcy system to close large institutions
if necessary.

“I think that there are regulatory impediments to resilience in the
financial markets,” he said. He said money market funds now have
“artificial incentives to run fast for the exits if a fund gets in
trouble.”

“I don’t think that a commitment by policymakers to greater
reliance on market discipline is going to be credible without further
measures to tie the government’s hands and prevent rescues and bailouts
going forward,” he said.

“We’ve done a little bit of that with Dodd-Frank, reining in the
Fed’s lending powers, but I think there’s still some anachronistic
authorities in there that don’t have a place.”

** MNI Washington Bureau: 202-371-2121 **

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