BT : Central bank rate should rise with market rate: Fed official

Business Times - 03 Dec 2009


Central bank rate should rise with market rate: Fed official

(NEW YORK) Charles Plosser, Philadelphia Federal Reserve Bank president, has said that the central bank should increase its main interest rate in the future in line with market rates, which will rise with the strengthening of the US economy.

The economy will expand 'about 3 per cent' from the fourth quarter of this year to the fourth quarter of 2010, and at a 'similar' pace in 2011, Mr Plosser told business leaders on Tuesday in Rochester, New York. Such growth is faster than the economy's underlying trend of 2.75 per cent, which means that investors will push market interest rates up to compensate for the risks of higher inflation, he said.

'To conduct monetary policy, we need to be forward-looking; and looking ahead, I see an economy that will be growing over the next two years, which means real interest rates will be rising,' Mr Plosser said. 'As they do, the federal funds rate should be permitted to rise with them.'

Central bankers on Nov 4 renewed their pledge to keep the overnight rate near zero for an 'extended period', saying that policy will remain unchanged as long as inflation expectations are stable and unemployment fails to decline. Mr Plosser's comments suggest that he would prefer the Fed move more quickly to withdraw liquidity from the economy.

In the short run, an 'exaggerated' danger of deflation has passed and inflation is under control, he said. Core consumer prices, which rose 0.2 per cent for a second month in October, on a year-over-year basis are up 1.7 per cent. The rate is below the 2 per cent level that many Fed officials have said they prefer.

'Unfortunately, the prospects for inflation over the next two to five years are much more uncertain,' Mr Plosser said.

Mr Plosser rejected the argument, put forth by Fed chairman Ben Bernanke, vice-chairman Donald Kohn and New York Fed Bank president Bill Dudley that the economic slack implied by high unemployment and low inflation help keep prices in check.

He cited 'theoretical and empirical evidence' which shows that low resource utilisation is difficult to measure and an unreliable predictor of inflation.

'So making policy decisions based on measures of such slack and particularly on forecasts of slack many quarters ahead becomes problematic,' he said. 'Ultimately, inflation is a monetary phenomenon and there is no question that current monetary policy is extraordinarily accommodative.' - Bloomberg