Bloomberg News

Easing in Recovery Hurts Fed Credibility, Kocherlakota Says

October 13, 2011

(Updates with comment on easing in 11th paragraph.)

Oct. 13 (Bloomberg) -- Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said the central bank has put its credibility at risk by easing during a year in which inflation rose and unemployment fell.

“The committee’s actions at the last two meetings are inconsistent with a systematic pursuit of its communicated objectives,” Kocherlakota said today in a speech in Sidney, Montana. “It follows that these actions diminish the committee’s credibility and so reduce the effectiveness of future committee actions and communications.”

The speech marked the first time Kocherlakota has spoken about policy since opposing a Federal Open Market Committee decision to sell $400 billion of short-term Treasury securities and replace them with $400 billion of longer-term securities.

“I believe that the FOMC’s ultimate effectiveness relies critically on its communication and the credibility of that communication,” Kocherlakota told business leaders from the Sidney area in eastern Montana. “I’ve dissented at the last two meetings because I believe that the committee’s decisions at those meetings diminish that requisite credibility.”

Fed Chairman Ben S. Bernanke said last week at a Joint Economic Committee hearing that the two-year-old recovery is “close to faltering.” The U.S. economy expanded at a 1.3 percent annual pace in the second quarter, up from 0.4 percent in the first quarter.

Change Held at Zero

The Fed meeting and Bernanke’s testimony to Congress came before an Oct. 7 report from the Labor Department showed the economy created 103,000 jobs in September, an improvement from the 57,000 positions added a month earlier.

Kocherlakota said the recovery has been slower than expected, adding “some have suggested that the unexpected slowness of the recovery is a justification for the FOMC’s increasing the level of monetary accommodation over the past couple of months. But I disagree with this argument.”

“As the economy recovers, the FOMC should respond by reducing the level of monetary accommodation,” Kocherlakota said.

“The FOMC should only increase accommodation if the economy’s performance, relative to the dual mandate, actually worsens over time,” he said, referring to the central bank’s goals of maintaining price stability and ensuring full employment.

Dissenting Vote

Dallas Fed President Richard Fisher and Philadelphia’s Charles Plosser also cast a dissenting vote at the Sept. 20-21 meeting. In August, the three Fed district bank chiefs objected to a pledge to hold the central bank’s interest rate near zero through at least mid-2013.

Kocherlakota said in response to audience questions that the plan to swap short-term debt for longer-term debt, known as Operation Twist for its attempt to bend the yield curve, is “not a game changer.” The policy will probably have stimulative effects roughly equivalent to cutting the Fed’s target interest rate by 0.5 percentage point, he said.

Kocherlakota also said that the Fed’s low-interest rate policy has “redistributional” effects on the economy.

“When we keep rates low that ends up helping some people more than it helps others,” he said, citing the example of retirees who may be living off fixed-income investments. “Those people have certainly been hurt by interest rate policy.” Still, overall, “the net benefit from stimulating the economy outweighs those losses.”

Stock Index Falls

The Standard & Poor’s 500 Index fell 0.3 percent to 1,203.64 at 4:30 p.m. in New York. The yield on the 10-year Treasury note fell three basis points to 2.178 percent. A basis point is 0.01 percentage point.

The Fed said some officials last month wanted to keep further asset purchases as an option to boost the economy as policy makers saw “considerable uncertainty” that U.S. growth will pick up, according to minutes of the meeting released yesterday in Washington.

“Actions speak louder than words,” Kocherlakota said. “The committee can claim that it intends to make monetary policy so as to fulfill its dual mandate. But the public will watch its actions carefully in this regard,” he said.

“If the committee fails to reduce its immense amount of accommodation in a timely fashion, the public will begin to doubt the committee’s claims about its goals,” he said.

Kocherlakota noted that the current 9.1 percent rate is an improvement from the 9.8 percent rate in November last year. The rate is little changed from January.

Inflation Accelerated

Inflation has accelerated since last year too. Prices rose 2.9 percent in August from a year earlier, according to the personal consumption expenditures index. Costs excluding food and energy rose 1.6 percent.

“In response to these changes in economic conditions, the committee should have lowered the level of monetary accommodation over the course of the year,” Kocherlakota said. “Instead, through actions taken at its last two meetings, the committee has raised the level of monetary accommodation. In this sense, the committee’s recent actions in 2011 are inconsistent with the evolution of the economic data in 2011.”

Most participants at the Fed’s last meeting favored giving additional information on the central bank’s goals for the economy and how they influence its decisions, the minutes said.

Policy makers also decided on Sept. 21 to reinvest maturing housing debt into mortgage-backed securities to help the depressed real estate industry and in part to keep the Fed’s Treasury holdings from getting too large and possibly causing a “deterioration in Treasury market functioning,” the minutes said.

Kocherlakota, 48, received his doctorate in economics from the University of Chicago. He taught at the University of Minnesota before becoming president of the Minneapolis Fed in October 2009.

--Editors: James Tyson, Vince Golle

To contact the reporter on this story: Joshua Zumbrun in Sidney, Montana at

To contact the editor responsible for this story: Chris Wellisz at

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