The Federal Reserve should take further action to stimulate the economy, or risk letting it fall into a vicious cycle of joblessness and deflationary pressures, top Fed official said on Friday.
Chicago Federal Reserve President Charles Evans framed the debate over further monetary policy accommodation by the U.S. central bank as one of “how much” and “how,” rather than whether it should take steps in the first place.
“The size of the unemployment gap, combined with the fact that inflation has been running below the level I consider consistent with long-term price stability, suggests that it would be desirable to increase monetary policy accommodation to boost aggregate demand and achieve our dual mandate,” said Chicago Federal Reserve President Charles Evans, according to text prepared for delivery at a Bank of France conference in Rome.
In casting his lot unequivocally with the doves, who tend to be driven more by concerns over employment than inflation, Evans joined William Dudley, president of the New York Fed, who said earlier today that further Fed action is likely to be warranted unless the economy improves.
Evans will rotate into a voting spot on the Fed’s policy-setting committee next year.
Economic growth is likely to slow further in the second half of 2010, and increase only moderately in 2011 and 2012, he said.
Meanwhile, inflation looks set to remain below desirable levels “over any reasonable forecast horizon,” he said. And high unemployment — now at 9.6 percent — cannot be attributed only to structural factors that would be beyond the ability of the Fed to affect, he argued.
Evans said one of his top concerns is “the possibility that we might be in a liquidity trap,” where businesses and households are so cautious about the future that they save more then they invest, even though short-term interest rates are at zero.
“The modern economic theory of liquidity traps indicates that the optimal policy response at zero-bound is to lower the real interest rate, almost surely by employing unconventional policy tools,” he said.
“Theory also indicates that, in the absence of such policy stimulus, the factors that generate high risk aversion could very well stifle a meaningful recovery, keep unemployment high and reinforce disinflationary pressures — clearly an undesirable equilibrium.”
In the coming weeks and months, Evans said, he will assess incoming data, update his forecast and weigh the best monetary policy response.
“I will be pondering two key issues: How much more should monetary policy do to reduce the shortfalls in meeting our dual mandate responsibilities for employment and price stability; and what tools should we use?”