Fed’s Kocherlakota Says 6.5% Unemployment No Rate Trigger

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the Federal Open Market Committee may choose not to raise the main interest rate when the jobless rate falls below 6.5 percent.

“The unemployment rate threshold is not a trigger for FOMC action,” Kocherlakota said in a speech today in Edina, Minnesota. He also said the committee’s guidance provides “a great deal of protection against undue inflationary pressures.”

The policy-setting FOMC affirmed last week it will keep the federal funds rate near zero as long as unemployment remains above 6.5 percent and the outlook for inflation does not exceed 2.5 percent. The committee also said it will leave the pace of asset purchases unchanged at $85 billion a month.

Should the central bank’s inflation outlook ever rise above 2.5 percent, its commitment to keep rates near zero “is off the table,” said Kocherlakota, who doesn’t vote on the FOMC until 2014. “I would see a breach of this threshold as being a cause for significant concern.”

Policy makers haven’t had a medium-term outlook for inflation as high as 2.25 percent during the past 15 years, the Fed district bank chief told a gathering of Minneapolis-area business leaders. That means an outlook of more than 2.5 percent “should be seen as being highly unusual” and prompt the FOMC “to strongly consider an aggressive response.”

Communications Policy

The central bank should give clearer guidance about the conditions that will prompt it to halt asset purchases, Kocherlakota said to reporters after his speech.

“We’re vague about asset purchases,” only saying “we’re going to continue the asset purchases until we have a substantial improvement in the labor market outlook,” Kocherlakota said. The Fed should give “more guidance about what that means, specific quantitative guidance.”

“Improvement in the labor market has been stronger,” Kocherlakota said, adding he is “pleasantly surprised by the strength in the private sector over the past couple months.”

By 2018, unemployment will probably decline to a range of 5.2 percent to 6 percent while inflation will be about 2 percent, he said in response to audience questions.

“The Fed will be successful in achieving its goals in terms of inflation and unemployment,” Kocherlakota said. “Private-sector forecasters share this confidence, that five years out we’re going to be looking at inflation and unemployment that have normalized.”

GDP Growth

Kocherlakota in his speech maintained his forecasts that gross domestic product probably will expand by 2.5 percent this year and 3 percent next year, and that unemployment will “continue to fall only slowly,” to 7.5 percent in late 2013 and 7 percent in late 2014. Inflation measured by the personal consumption expenditures index “will remain subdued” at 1.6 percent in 2013 and 1.9 percent in 2014, he said.

Kocherlakota repeated his view that “monetary policy is currently not accommodative enough,” and that the central bank should do more to spur economic growth and hiring.

The Fed started a third round of quantitative easing in September with $40 billion of monthly agency mortgage-backed securities purchases. The program was expanded in December with $45 billion of monthly purchases of Treasury notes.

Kocherlakota, 49, was among the earliest advocates of tying the Fed’s interest-rate policy to economic data, first calling for the change in a speech in September. The FOMC adopted a variation of what the district bank president advocated in the committee’s December meeting.

Kocherlakota spoke to the Bloomington, Eden Prairie, Edina and Richfield chambers of commerce.

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