–Inflation Likely To Drift Upward In Coming Quarters

NORFOLK, Va. (MNI) – Richmond Federal Reserve President spoke
Thursday night of the difficulty that the Federal Reserve will face in
determining the proper time to begin tightening monetary policy, with
officials wary of hiking rates too soon and threatening the fragile
economic recovery.

In remarks prepared for the Hampton Roads Virginia Regional Forum
in Norfolk, Virginia, Lacker predicted that while inflation is likely to
drift upwards in coming quarters — barring unanticipated shocks,
inflation expectations are stable right now.

The stability of inflation expectations implies confidence that the
Federal Reserve will act to keep inflation low and stable as the
recovery continues, he said, a confidence that will make monetary policy
challenging for the foreseeable future.

“The difficulty, of course, is that no one wants to tighten policy
prematurely and needlessly dampen the recovery,” Lacker said. “So
recognizing the right time to begin normalizing our monetary policy
settings is going to be hard, and reasonable people can differ about
this.

“For my part, I will be looking for the time at which economic
growth is strong enough and well enough established to warrant raising
our policy rate.”

He added that, “As a technical matter, whenever we decide to begin
normalizing policy it will be straightforward to sell assets, shrink our
balance sheet, and raise the level of short-term interest rates.”

Giving his outlook for the broader economy, Lacker said he believes
consumer spending and business investment will continue to be strong
enough to keep growth in overall activity on an upward trajectory,
though at a slower pace compared to past recoveries.

With inflation remaining low and fairly stable, the recovery is
likely to continue at a pace that is generally moderate, Lacker
predicted, but variable over time and across sectors.

So while many analysts appear worried by recent economic indicators
that have come in below expectations, Lacker said he would not be
surprised to continue to see “somewhat choppy economic reports for a
time.”

“This pattern is not at all inconsistent with moderate growth,” he
added, “one can’t always be better than expected, after all — so it’s
wise not to overreact to every crosscurrent in the data flow.”

Consumer spending is on an upswing, Lacker noted, and having risen
so far in 2010 at a rate of 2.9%, “That turnaround is likely to be
durable.”

The brighter picture also extends to business investment, with
Lacker predicting “robust increases” in spending for business equipment
and software this year — and beyond.

And while some worry that the situation in Europe could spillover
to the U.S., Lacker said the uncertainty regarding fiscal adjustments
and banking conditions is likely to be resolved without major effects on
U.S. growth.

“Although, to be fair, more adverse outcomes are conceivable,” he
hastened to add.

As for sectors that will continue to lag the economic recovery,
Lacker said leading indicators suggest that nonresidential construction
will continue to be very soft for an extended period. He also does not
expect housing construction to expand much “from its current sluggish
pace.”

And with the revenue of many U.S. state and local governments “in
the doldrums,” Lacker said their budgets are likely to remain “quite
constrained” for some time.

He also issued a warning on the current path of U.S. fiscal policy,
arguing that a failure to act would set an adverse sequence of events in
motion.

“Investors will be increasingly reluctant to hold more Treasury
securities, yields will consequently rise significantly, the cost of
capital will increase for firms producing in the United States, capital
formation will suffer, productivity growth will slow, and thus real
household incomes will stagnate,” he said.

“In broad terms we all know what needs to be done — cut spending
or raise taxes,” the Richmond Fed president concluded, “The sooner we
make the necessary adjustments, the longer the period over which we can
spread out the adjustment cost, and the more likely we are to avoid a
fiscal crisis of the type Greece is now experiencing.”

** Market News International **

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