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Fed’s Kocherlakota Says Central Banks Could Guarantee Debts

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said a central bank seeking to control inflation needs to find a balance between supporting a government’s debt issuance and allowing for sovereign default.

“It may turn out to be optimal for central banks to guarantee fiscal authority debts in some situations,” Kocherlakota said today in a panel discussion in Chicago. If so, economists may need to consider control of inflation as “something that is done jointly by the fiscal authority and the central bank.” He didn’t back such guarantees, saying a central bank furthers its independence by avoiding “interventions.”

Kocherlakota, 47, who dissented this month and last month from the Fed’s expanded use of unconventional monetary tools to ease credit, didn’t comment on the economic outlook or interest rates in his prepared remarks. The comments weren’t focused on a particular situation, such as the prospect of a default by Greece or an increase in the U.S. debt limit.

A central bank can have a “large amount of control over the price level” if it’s “willing to commit to letting the fiscal authority default,” Kocherlakota said in the text of comments at a panel discussion for the CME Group-MSRI Prize in Innovative Quantitative Applications.

“Such a commitment may expose the country to risks of short-term and medium-term output losses,” the former University of Minnesota economics professor said. “How this trade-off should best be resolved awaits future research.”

The award is being given to Thomas Sargent, an economist at New York University.

Download: Fed's Kocherlakota on Policy and Sovereign Debt

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