Fed `Extended Period' Pledge for Low Rates Defended by Kohn, Kocherlakota

Two Federal Reserve policy makers defended the central bank’s pledge to keep interest rates low for an “extended period,” saying it could be altered to account for improvements in the economy.

“Commitments to maintain interest rates at a given level must be properly conditioned on the evolution of the economy,” Fed Vice Chairman Donald Kohn said. Narayana Kocherlakota, president of the Minneapolis Fed, said the pledge doesn’t stop the Fed from raising rates “if economic conditions change appropriately, whether that’s in three weeks, three months or three years.”

Central bankers will consider whether to change their low- rate pledge next month after the economy added 290,000 jobs in April, the most in four years. Kansas City Fed President Thomas Hoenig has dissented against the language at all three policy meetings this year, saying in April it limited the Federal Open Market Committee’s “flexibility to begin raising rates modestly.”

Presidents Richard Fisher in Dallas, James Bullard in St. Louis and Charles Plosser in Philadelphia have also expressed reservations about the pledge, citing in part concerns that medium-term inflation may be too high.

Fed officials are likely to weigh the effects of financial turmoil in Europe on U.S. growth when they next meet June 22-23. Tighter financial conditions around the world could cause the Fed to extend its low interest rate policy, analysts said.

‘Pretty Quickly’

“If financial conditions get back to normal and the data comes in stronger than the Fed expects, decisions on changing the language could happen pretty quickly,” said Tom Gallagher, senior managing director at International Strategy & Investment Group Inc. in Washington. “The odds are against it changing in June.”

Kohn and Kocherlakota, in separate appearances yesterday, both emphasized that the pledge for low rates doesn’t imply any specific timetable and instead depends on the outlook for inflation and unemployment. The Fed’s target rate for overnight loans among banks has been between zero and 0.25 percent since December 2008.

“We’re keeping interest rates low to keep unemployment from going any higher, and we feel safe in doing so because there seems to be little threat of inflation,” Kocherlakota said in a speech to the Eau Claire Area Chamber of Commerce in Altoona, Wisconsin.

Labor Market Outlook

Kocherlakota, who doesn’t vote this year on the rate- setting FOMC, said the unemployment rate, now at 9.9 percent, is unlikely to fall below 9 percent in 2010 or 8 percent next year. While the labor market “is starting to function better,” he said, “the recovery will be slower than we would like.”

“The truly good news is about inflation,” said Kocherlakota. A gauge of inflation watched by the Fed, the personal consumption expenditures index, rose at a 1.5 percent annualized pace in the first quarter and is likely to remain at that level for the rest of the year, he said.

The economic recovery is “well under way,” Kocherlakota said, predicting growth of about 3 percent at an annual pace this quarter and around 3.5 percent over the next two years.

Growth in the U.S. will be hindered by higher tax rates needed to offset the rising national debt, declining bank lending and an expansion in Europe that’s likely to be restrained by the continent’s debt crisis, he said.

The number of Americans filing claims for jobless benefits dropped for a fourth straight week, a sign that employers are retaining more workers as the economy expands.

Extended Payments

Initial jobless claims fell by 4,000 to 444,000 in the week ended May 8, higher than the median forecast of economists surveyed by Bloomberg News, the Labor Department said yesterday. The number of people receiving unemployment insurance increased and those getting extended payments fell.

Some companies are hiring as sales increase. General Electric Co., the world’s largest maker of jet engines, power- generation equipment and locomotives, increased the number of jobs it plans to add in Michigan to more than 1,300 with the creation of 220 aerospace manufacturing positions, the Fairfield, Connecticut-based company said last week.

“The economy is slowly getting its legs,” the Dallas Fed’s Fisher said yesterday in a speech in Odessa, Texas. Asked later by reporters if the time has come to consider raising rates, he said: “I don’t think we’re there yet.”

Treasuries rose yesterday as stocks fell and the euro slid to a 14-month low on concern fiscal tightening across Europe will limit growth. The yield on the benchmark 10-year note decreased 4 basis points to 3.53 percent at 4:39 p.m. in New York.

Emergency Authority

Kohn, speaking at a conference at Carleton University in Ottawa, advocated continuing the central bank’s emergency loan authority, which Congress is now planning to curb as part of an overhaul of financial regulation.

“Our ability to preserve financial stability may be enhanced by making sure the Federal Reserve has authority to lend against good collateral to other classes of sound, regulated financial institutions,” said Kohn, 67, who will retire June 23. President Barack Obama has chosen San Francisco Fed President Janet Yellen, 63, to succeed him.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Greg Quinn in Ottawa at gquinn1@bloomberg.net.

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