By Steven K. Beckner

Continued

While saying he does not see the “the Committee’s current
resolution of this trade-off as being intrinsically problematic,” he
said, “What I do see as problematic is that the Committee’s resolution
of this trade-off appears to be changing over time.”

“In particular, the Committee’s actions in 2011 suggest that it is
more willing to tolerate inflation risks-and the concomitant medium-term
and long-term employment losses-than it was in 2010,” he continued. “If
this drift in inflation risk tolerance were to persist, or were expected
to persist, it could give rise to a damaging increase in inflationary
expectations.”

Kocherlakota’s relatively caustic comments did not end there.
Despite Bernanke’s stated desire for increased “transparency,” he
suggested that, if anything, the FOMC’s communications have become more
muddled.

“I believe that the FOMC’s decision-making in 2011 has introduced a
lack of clarity about its monetary policy mission,” he declared, before
going on to suggest some remedies.

“I believe that this lack of clarity can and should be addressed in
two steps,” he said. “First, the FOMC should explain how it plans to
resolve the trade-off between inflation and unemployment in making its
future decisions.”

“Second, on an ongoing basis, the Committee should provide explicit
communication about how its chosen actions are indeed consistent with
its pre-announced resolution of the inflation-unemployment trade-off,”
he continued. “Here, I believe that the use of metrics like the mandate
dashboard provides a useful form of discipline-both on our own actions
and on the public’s understanding of those actions.”

He quoted Bernanke saying, “Transparency regarding monetary policy
… not only helps make central banks more accountable, it also
increases the effectiveness of policy.”

Then he said, “I agree completely with this sentiment. And I see my
two recommended future steps-clearer communication about trade-offs and
the explicit use of metrics like the mandate dashboard-as promoting
exactly the kind of transparency that Chairman Bernanke was describing.”

By the dual mandate “dashboard,” Kocherlakota was referring to how
inflation and unemployment are doing and are projected to do relative to
the FOMC’s longer term forecasts, which are considered a type of target.

“The FOMC’s dual mandate…is to keep inflation at 2 percent or a
bit under and to promote maximum employment-that is, to keep
unemployment low,” he said. “But how does the FOMC make its choices at
each meeting so as to achieve these goals?

Likening the Fed to the driver of a car looking at the dashboard,
he said, “I believe that it is useful to think of a driver who is trying
to maintain a car speed. To do so, he’ll vary pressure on the
accelerator in response to changes in road conditions, current and
expected: hills, valleys, rough pavement, headwinds. In the same way,
the FOMC varies its chosen level of monetary accommodation in response
to changes in current and expected economic conditions.”

When the FOMC launched QE2 in November 2010, he recalled that
unemployment was higher at 9.8% and inflation lower than now. He said he
dissented in August and September because unemployment had fallen and
inflation risen. And he predicted that trend will continue.

“The fourth quarter is not yet complete, but it looks like
fourth-quarter-over-fourth-quarter PCE core inflation in 2011 will be
around 1.9%,” he said. “I expect it to rise over the next couple of
years to slightly above 2%. At the same time, unemployment is 9.1%. I
expect it to fall slowly to around 8 percent by the end of 2013.”

Given the change in those indicators since last November, “the
Committee should have lowered the level of monetary accommodation over
the course of the year,” Kocherlakota said. “Instead, the Committee
chose to raise the level of monetary accommodation.”

“The Committee’s actions in the last two meetings are thus
inconsistent with the evolution of the economy in 2011,” he said. “Given
this inconsistency between the Committee’s actions and the evolution of
the economy, I decided to dissent in August and September.”

Kocherlakota acknowledged that the recovery has proceeded more
slowly than the FOMC projected last year and earlier this year, but said
that does not justify additional easing.

“Logically, if the economy recovers much more slowly than expected,
then the FOMC should respond by reducing the level of monetary
accommodation much more slowly than expected,” he said. “The FOMC should
only increase accommodation if the economy’s performance and outlook,
relative to the dual mandate, actually worsens over time.”

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** Market News International **

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