Jan. 11 (Bloomberg) -- Federal Reserve Bank of Philadelphia President Charles Plosser said policy makers should watch the risk of accelerating mid-term inflation “very carefully” after injecting record stimulus into the economy.
“With the very accommodative stance of monetary policy, the inflation situation is one that bears careful watching in order to ensure that inflation pressures remain contained over the medium run,” Plosser said today in a speech in Rochester, New York. “Inflation most often develops gradually, and if monetary policy waits too long to respond, it can be very costly to correct.”
Fed policy makers are divided over whether they should increase accommodation to bolster an expanding economy. Chicago Fed President Charles Evans said today in Lake Forest, Illinois, that signs of improvement in the economy are modest and the central bank should push forward with “substantial” easing.
Plosser told reporters after his speech that he’s been “pretty encouraged” by recent economic data and questioned whether more stimulus is necessary.
“Inflation is higher and unemployment is lower” than before the Fed embarked on its second round of bond buying, Plosser said. “If someone wants to engage in more accommodation,” then “you sort of have to say ‘Why?’”
The Standard & Poor’s 500 Index was little changed at 1,291.83 at 3:24 p.m. in New York. The yield on the benchmark 10-year Treasury note fell to 1.9 percent from 1.97 percent.
Plosser, who dissented against the central bank’s stimulus measures in August and September, said the “potential costs outweighed the potential benefits of further accommodation.” The steps risked a “steady rise in inflation over the medium term without much of a drop in the unemployment rate,” he said.
The Fed’s pledge in August to keep interest rates near zero until mid-2013 “raised particularly difficult communication challenges,” Plosser said. He reiterated his view that the Fed may need to raise rates before then.
“Despite past challenges, I remain optimistic about the economy’s future,” said Plosser, who predicted U.S. economic growth of 3 percent for 2012 and 2013. “Prospects for labor markets will continue to improve, with job growth strengthening and the unemployment rate falling gradually over time.”
May Drop Further
Plosser forecast that the “uncomfortably high” unemployment rate would fall to about 8 percent this year, while saying that in his “more optimistic moments,” he thought it might drop further. The unemployment rate fell to 8.5 percent in December, the lowest in almost three years, according to the Labor Department.
“While there is a long way to go in restoring a vibrant labor market, I am encouraged by the employment reports released over the past several months,” Plosser said. Payrolls rose by 200,000 last month, more than economists forecast.
Inflation expectations will be “relatively stable” and price acceleration will “moderate’ as commodity prices stabilize or decline, Plosser said.
The economy still faces “downside risks,” with the largest being the impact of the sovereign debt crisis in Europe, Plosser said. The U.S. government’s “inability to establish a clear plan to put our fiscal policy on a sustainable path” and consumers “restoring the health of their balance sheets” may also weigh on growth, Plosser said.
Plosser told reporters that the “housing market still remains a big problem for the recovery,” and that the study Chairman Ben S. Bernanke sent Congress last week was an “effort” to outline some policy options to help boost real estate. The 26-page staff study said Fannie Mae and Freddie Mac might have to bear greater losses to stoke a broader recovery.
The Fed needs to be “careful” about “becoming too engaged in fiscal policies” because it threatens the central bank’s independence, Plosser said. “I’m not sure the Fed can do much about the housing problem,” he said. “I would prefer we engaged in things that were less confused with fiscal policy.”
Plosser said he “fully” supports the Federal Open Market Committee’s decision to start releasing policy makers’ interest rate forecasts after their Jan. 24-25 meeting.
“Greater clarity helps monetary policy become more effective at promoting its congressionally mandated goals of price stability, maximum employment, and moderate long-term interest rates,” he said.
Revealing the forecasts isn’t intended as an easing measure and is “about being clear about what we’re doing,” Plosser said. “What we’re doing is describing to the public the range of policy views that the committee has,” and the goal is to “align the expectations of the market with the views of the committee,” he said. While pushing back expectations for when the Fed will raise its benchmark interest rate may be a “consequence,” it isn’t an “objective,” he said.
The forecasts also shouldn’t be viewed as a “commitment,” and won’t reduce the central bank’s flexibility to alter its policies in part because they’re released every quarter, Plosser said.
The Fed should go further to improve the transparency of its policies, Plosser said, reiterating his call for the adoption of an “explicit numerical inflation objective.” Policy makers should also explain why they can’t do the same for their goal of full employment, he said.
“I do not believe the FOMC should set a fixed numerical objective for something that it does not directly control and cannot accurately measure,” Plosser said.
While the Fed’s dual mandate poses a “communications challenge” for that reason, it isn’t an “impediment” to adopting an inflation target, he told reporters.
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