Fed’s Kohn: Economy showing signs of stabilization

May 24, 2009

Federal Reserve Vice Chairman Donald Kohn makes two big points in a speech today at Princeton: 1) Obama’s big spending won’t push up rates anytime soon; and 2) there will be no rush for the Fed to get constrictive:

Kohn on fiscal expansion:

In this situation, fiscal stimulus could lead to a considerably smaller increase in long-term interest rates and the foreign exchange value of the dollar, and to smaller decreases in asset prices, than under more normal circumstances. Indeed, if market participants anticipate the expansionary fiscal policy to be relatively temporary, and the period of weak economic activity and constrained traditional monetary policy to be relatively extended, they may not expect any increase in short-term interest rates for quite some time, thus damping any rise in long-term interest rates.  … All told, the result is likely to be considerably less of the usual crowding out of fiscal stimulus in these circumstances, thereby increasing the effectiveness of fiscal policy to boost the level of aggregate economic activity in the short to medium term.

Kohn on the Fed’s next move:

In my view, the economy is only now beginning to show signs that it might be stabilizing, and the upturn, when it begins, is likely to be gradual amid the balance sheet repair of financial intermediaries and households. As a consequence, it probably will be some time before the FOMC will need to begin to raise its target for the federal funds rate. Nonetheless, to ensure confidence in our ability to sustain price stability, we need to have a framework for managing our balance sheet when it is time to move to contain inflation pressures.

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