The U.S. economy is likely to emerge from its downward slide next year and the Federal Reserve should keep its it eye on the risk that inflation may accelerate along with growth, a top Fed official said on Friday.
"Many analysts expect the U.S. economy to regain positive momentum sometime in 2009," Richmond Fed Bank President Jeffrey Lacker said in a speech to the Tech Council of Maryland.
"That strikes me as a reasonable expectation," he said.
He said the downturn in the economy poses challenges for monetary policy in the period ahead, including a possible rise in inflation expectations.
"It's essential that we not let inflation drift from view," Lacker said.
"It may seem premature to be worrying about how inflation behaves after the recession is over, but we need to be sure our policy remains consistent with a strategy that does not allow inflation to ratchet up over the business cycle," he said.
Lacker, one of the Fed's most vocal inflation hawks, will be among the voters next year on the central bank's interest-rate setting panel.
Financial markets are in one of the most serious episodes of turmoil in decades, and major economies around the world have tipped, or are tipping into recession. U.S. stocks fell sharply on Thursday, taking the benchmark S&P 500 down more than 52 percent below its October 2007 record high.
Stocks were up slightly on Friday as investors hunted for bargains, but the future of No. 2 U.S. bank Citigroup kept a lid on gains.
The Fed has cut rates by 4.25 percentage points to 1 percent since September 2007 to put a floor under the faltering economy, and is expected to chop rates by another half-percentage point at its Dec. 15-16 meeting.
October consumer prices posted their steepest decline on record on lower energy costs, raising fears the United States could be facing a debilitating deflationary spiral as Japan did in the 1990s.
Deflation is considered a threat to the economy because a pattern of falling prices causes consumers and businesses to put off purchases in expectations of even lower prices, dragging the economy down further.
Lacker acknowledged that risks of sustained deflation have risen recently, but suggested any worry about a damaging protracted period of falling prices is overstated.
"We'll set interest rates appropriately to get through this with a low and stable inflation rate," he told reporters after his speech.
"And a by product of that will be that we avoid deflation," he added. "We don't expect deflation. That's evident from the forecast."
Lacker further said the central bank will continue to pursue its goal of fostering non-inflationary growth even as its primary tool, the benchmark interbank lending rate, is very low.
"I don't see our inability to reduce the funds rate below zero as hampering our ability to do monetary policy," he said.
A central concern of monetary policy is the quantity of money, and to say the central bank is conducting monetary policy by changing interest rates is short-hand for saying the central bank is changing the money supply enough to induce a change in interest rates, Lacker said.
"When interest rates get low, we can still change the money supply, we can still conduct monetary policy," he added.
The central bank has "a wide variety of choices" about what assets it can acquire to expand the monetary base at low interest rates, he said.
Lacker argued the economy could be seen as ready to rebound next year.
Monetary policy is "quite stimulative," he said. Also, the major shocks that have dampened economic activity this year "have subsided already or are in the process of doing so," he added.
