Lacker Says Fed Should Plan Withdrawal of Stimulus After QE2 Program Ends

Federal Reserve Bank of Richmond President Jeffrey Lacker said the central bank should turn its attention to withdrawing stimulus after completing its $600 billion bond purchase program at the end of next month.

“Barring significant unexpected developments, this should be the high-water mark for monetary stimulus in this cycle, with the focus going forward on the timing and pace of stimulus withdrawal,” Lacker said today in a speech in Arlington, Virginia.

Fed Chairman Ben S. Bernanke and the Federal Open Market Committee have said they will complete their bond purchase program, known as QE2 for the second round of quantitative easing, at the end of June. The central bank has yet to announce its subsequent plans. St. Louis Fed President James Bullard noted in a speech last week that monetary policy may go “on hold” to see how the economy develops.

“While timing and pace will depend upon how the economy behaves, I believe it will be important to remember the lesson of the last recovery -- namely, that inflation is capable of rising even if the level of economic activity has not returned to its pre-recession trend,” Lacker said to a gathering of northern Virginia business and community leaders.

Policy Tightening

“It may be necessary to initiate policy tightening well before the unemployment rate has fallen to a rate we would expect to see over the long run,” Lacker said. “While I don’t want to minimize the extent of lingering weakness in economic activity, we should not lose sight of the fact that the economy has been expanding at a significant pace and the fundamentals for future growth are strong right now.”

Speaking to reporters after the speech, Lacker declined to outline a timeline for the withdrawal of stimulus, saying it depends on how the economy unfolds.

“This is the point in the business cycle when the risk of losing a bit of credibility and risk of losing ground on inflation is highest,” he said. It’s “far better to act preemptively than get behind the curve on inflation and have to catch up,” he said.

Lacker said longer-term inflation expectations had risen to the top of the range he’s comfortable with.

“If you go above that range you have to really be concerned,” he said. “We’re at the very upper end of the range right now.”

Economy Added Jobs

The Labor Department said last week the economy added 244,000 jobs in April with non-government employers added 268,000 jobs, the best month for the private sector of the economy since 2006.

Other job market data remain weak, as the unemployment rate has been stuck near 9 percent or higher for 25 months. The number of people who filed for jobless benefits for the first time rose to 474,000 last week for the most new filings since August, according to a separate Labor Department report.

Speaking to reporters, Lacker said the rise in claims may be “pretty temporary,” while the April payrolls report is a “solid signal” the labor market is “definitely healing.”

Consumer confidence dropped last week to the lowest level in more than a month as rising fuel costs squeezed American household budgets. The Bloomberg Consumer Comfort Index decreased to minus 46.2 in the week ended May 1, the lowest level since the end of March. In 2010, the index average reading was minus 45.7, showing consumer’s comfort has yet to show sustained improvement.

Spending Grew

“Consumer spending growth is likely to be somewhat restrained for a time, as households adjust to the bigger bite these higher prices take out of their take-home pay,” Lacker said. “I would be concerned if I expected substantial further price increases, but at this point, futures markets are pricing in modest declines in petroleum products. If the markets are right about that, the effect of energy prices on consumer spending should only be temporary.”

The economy grew at a 1.8 percent pace in the first quarter of 2011, according to Commerce Department data. The slowdown in growth will probably prove to be “transitory,” Bernanke said in an April 27 press conference.

In a statement before Bernanke’s press conference the FOMC unanimously agreed to complete their plan to purchase $600 billion of bonds through June to avert deflation and boost growth. They also pledged to keep interest rates “exceptionally low” for an “extended period.” The Fed said in its statement that inflation from commodities would likely prove “transitory” as well.

Lacker said he agrees with this assessment.

“There are good reasons to believe this surge is temporary,” he said. “In the absence of further energy price increases, we are likely to see inflation subside to a rate closer to 1.5 percent.”

Fed presidents rotate voting on monetary policy, with Lacker, 55, voting next year. The FOMC next meets in Washington on June 21-22.

To contact the reporter on this story: Joshua Zumbrun in Arlington, Virginia at jzumbrun@bloomberg.net.

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net