–Boston Fed Chief Expects Disinflation to Continue Over Near-Term

By Claudia Hirsch

NEW YORK (MNI) – Boston Federal Reserve Bank President Eric
Rosengren said Wednesday the accommodative U.S. monetary policy is the
right course for now, as disinflation persists and economic slack
continues.

“My view is that with inflation expectations stable, core PCE
inflation rates declining, and significant excess capacity in the
economy, accommodative monetary policy remains appropriate,” Rosengren
said in remarks prepared for delivery at a dinner hosted by the Money
Marketeers of New York University.

He said he expects the inflation rate to continue falling “over the
near term,” despite the current buildup in banks’ excess reserves.

Both inflation and unemployment “diverge significantly” from the
Fed’s long-term goals, Rosengren said. Though the economy is “beginning
to recover” from the Great Recession, but it remains vulnerable.

“While real GDP began to increase in the third quarter of last
year, growth so far has been insufficient to improve conditions much in
the labor markets,” he said.

Real estate markets, both residential and commercial, “are, at
best, stabilizing,” he said. Bank closures and bad loans are presenting
“financial headwinds to the economy,” even while financial markets have
“improved significantly” since the darkest days of the crisis.

“And clearly — as the headlines of the past week have highlighted
— financial problems abroad still have the potential to result in
slower U.S. exports, and may hold potential further problems for global
financial institutions,” he said, referring to Europe’s sovereign debt
predicament.

U.S. economic growth over the next 12 months should help improve
the labor market, he said, but “it is likely to take years before we
approach the growth and inflation rates that would really reflect
achievement of the two elements of the Federal Reserve’s dual mandate.”

He noted that most forecasts suggest recovery from the current
recession will start slowly and accelerate over time, as was the case in
each of the last two economic revivals.

One potential inflationary threat — the Fed’s massively enlarged
balance sheet — will right itself over time, if slowly, he said.

So far, banks’ excess reserves have not nudged prices upward. But
should that change, Rosengren said, the Fed has a “variety of tools” to
hasten the its asset contraction, including outright sales of long-term
assets and increasing interest paid on reserves.

“Fundamentally, decisions about shrinking our balance sheet — like
decisions to tighten interest rates — should be conditional on economic
conditions.”

Meanwhile, Rosengren said, there is “little evidence” of any asset
bubbles at present in the financial markets. If one were to arise,
however, tightening short-term interest rates would be but a “blunt, and
possibly ineffective, tool against the exuberance of investors in a
particular asset.”

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