Kocherlakota Says Rate Increase May Be Needed This Yeas

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank may need to begin raising interest rates as soon as this year as inflation may exceed its 2 percent target next year.

“My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012,” Kocherlakota said today in Nicollet, Minnesota.

Federal Open Market Committee members expressed no sentiment for increasing monetary accommodation unless the U.S. economic expansion falters or prices rise at a rate slower than its 2 percent target, according to minutes of their March 13 meeting. U.S. employers added 120,000 jobs in March, the fewest in five months, a report showed April 6.

Kocherlakota said that he sees inflation, as measured by the personal consumption expenditures index, of around 2 percent this year, rising to 2.3 percent in 2013. He expects the unemployment rate to fall to 7.7 percent at the end of 2012 from its current level of 8.2 percent. By the end of 2013, he expects an unemployment rate of around 7 percent, he said.

The regional bank chief said he wouldn’t rule out that higher rates may be warranted as early as the first half of 2013. He also said accelerating the policy change involves risks to the recovery.

‘Policy Levers’

“If the sense of the committee was to move the date to early 2013 I would be open to that possibility,” Kocherlakota told reporters after his remarks to the Southern Minnesota Initiative Foundation. ““That’s something I’d be happy to talk about and interested in thinking about but I think there’s always a danger in moving policy levers too much too fast.”

Fed presidents rotate voting on monetary policy, with Kocherlakota next voting in 2014. The Minneapolis Fed chief dissented from two decisions of the FOMC last year to increase monetary stimulus.

“The outlook for the unemployment rate has improved, and the outlook for inflation has risen since January 2011,” Kocherlakota said. “Since the beginning of last year, the FOMC actually added more monetary accommodation. I would say that I see no need for still more accommodation at this time.”

The FOMC saw the strengthening economy reducing the need for more stimulus even as it planned to hold the benchmark interest rate near zero at least through late 2014, the March 13 minutes showed.

Economic Growth

The world’s largest economy probably expanded 2 percent in the first quarter of this year and will accelerate to 2.2 percent growth in the second quarter, according to the median of 74 economist estimates in a Bloomberg News survey. Unemployment fell to 8.2 percent last month, the Labor Department reported last week.

Kocherlakota said he saw evidence that the economy’s productive capacity has been damaged by the collapse in household wealth and this, as well as a drop in demand, is restraining the recovery. The loss of wealth from the collapse of the housing bubble deprived households of capital that could have been used to start new businesses while also making existing firms more reluctant to hire.

Productive Capacity

Both of these forces “reduce the productive capacity of our economy by making it harder for destroyed jobs to be replaced by created jobs,” he said.

If weak demand were to blame for the low levels of output, then “inflation should be well below the Fed’s target of 2 percent, and possibly falling,” Kocherlakota said. “This has not been the case. Hence, it does not appear that demand is significantly below the productive capacity of the United States,” he said.

The economy will grow “only moderately,” at around 2.5 percent to 3 percent over the next two years, Kocherlakota said.

The Minneapolis Fed chief dissented from a FOMC pledge in August to keep interest rates near zero through mid-2013, and a decision in September to sell $400 billion of short-term Treasuries and buy $400 billion of longer-term securities. He opposed the central bank’s decision to increase accommodation at a time when the economy was showing signs of healing.

Kocherlakota, 48, was an economics professor at the University of Minnesota before becoming head of the regional bank in October 2009. He was an economist at the Minneapolis Fed from 1996 to 1998.

To contact the reporters on this story: Jeff Kearns in Nicollet, Minnesota at jkearns3@bloomberg.net; Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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