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Fed’s Evans Says It’s ‘Imperative’ to Escape Liquidity Trap

Federal Reserve Bank of Chicago President Charles Evans said further monetary stimulus is needed now to help the U.S. economy escape from a “liquidity trap.”

“There is simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in a speech today in Muncie, Indiana. “It is imperative to undertake action now.”

Evans, 53, voted against the Federal Open Market Committee’s November decision to maintain its level of stimulus, casting the U.S. central bank’s first dissent in favor of further easing since December 2007. His vote contrasted with those by three of his colleagues, Dallas Fed President Richard Fisher, Charles Plosser of Philadelphia and Narayana Kocherlakota of Minneapolis, who dissented against further easing in August and September.

Evans renewed his calls for the Fed to pledge to hold interest rates exceptionally low until unemployment comes down, so long as inflation in the medium term does not breach 3 percent. Evans said that such a policy represents a “middle ground” between economists who believe extraordinary actions are needed to escape a liquidity trap and those who believe that structural changes to the economy will cause monetary policy to increase inflation.

‘Little More Positive’

“The most recent data have been a little more positive but I think the challenges the economy faces over the next two years continue to be strong enough that more accommodation would be a good idea,” Evan told reporters after his speech. “After providing additional forward guidance additional asset purchases could be helpful in order to further improve that.”

“At any particular time, depending on what the proposal in front of us is, if there’s a call for more accommodation I’m usually for it,” Evans said, adding that “communication is very important. I think that would be the first step.”

“Monetary policy can only do so much,” Evans said in response to audience questions, citing conditions in the mortgage market that are preventing many homeowners from refinancing their mortgages. “I think it’s important for all public policies to be focused on what can help provide the right fundamentals for the economy,” Evans said.

Fed policy makers “have been disappointed so many times in putting a more optimistic forecast forward,” he said in the question-and-answer session. “I’ve come to the opinion that the financial crisis has imparted way more headwinds for our entire economy.”

‘Inflation Safeguard’

“Suppose the structural impediments scenario turns out to be correct,” Evans said earlier in his speech. “In this case, inflation will rise more quickly and without any improvements to the real side of the economy. In such an adverse situation, the inflation safeguard triggers an exit from the now-evident excessive policy accommodation before inflation expectations become unhinged.”

By unwinding stimulus at 3 percent inflation, policy makers would “know that we had made our best effort,” Evans said at the Ball State University Center for Business and Economic Research “Annual Outlook Luncheon.”

Consistent Proposal

Evans said that his proposal is “consistent” with the most recent research, “which shows that improved economic performance during a liquidity trap requires the central bank, if necessary, to allow inflation to run higher than its target for some time over the medium term.”

In a liquidity trap, additions to the money supply fail to stimulate the economy. By raising inflation, the Fed can further lower real interest rates and discourage excess saving.

Fed policy makers are considering changing the way they communicate their policy goals and economic forecasts to the public. Janet Yellen, vice chairman of the Fed, said in an Oct. 21 speech that the proposal by Evans is “potentially promising.”

Evans said that inflation is “likely to remain moderate over the foreseeable future.” Forecasts released after the Fed’s Nov. 1-2 policy meeting show that policy makers expect inflation to settle between 1.5 percent and 2 percent in coming years. “My own assessment is that inflation will be at the lower end of these ranges,” he said.

Economy, Jobs

The Labor Department reported Dec. 2 that the economy added 120,000 jobs in November and the unemployment rate dropped to 8.6 percent from 9 percent in October, in part because people dropped out of the labor force.

“Without new developments or changes in policy, I don’t believe the U.S. economy is poised to achieve escape velocity anytime soon,” said Evans, who represents a five-state district with some of the highest U.S. jobless rates.

Michigan had 10.6 percent unemployment in October and Illinois had 10.1 percent. Nevada had the highest unemployment that month at 13.4 percent.

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