Ann Saphir contributed to this post
Minneapolis Federal Reserve President Narayana Kocherlakota has gone from being one of the U.S. central bank’s more hawkish characters to arguably its most dovish. In line with this transformation, Kocherlakota told a conference sponsored by the University of Chicago’s Booth School of Business that the Fed, despite its extensive bond-buying over the last few years, has not done enough to spur growth.
The FOMC has responded to this challenge by providing a historically unprecedented amount of monetary accommodation. But the outlook for prices and employment is that they will remain too low over the next two to three years relative to the FOMC’s objectives. Despite its actions, the FOMC has still not lowered the real interest rate sufficiently in light of the changes in asset demand and asset supply that I’ve described.
To get a sense of what he means, see the graphs below: U.S. inflation continues to undershoot the Fed’s 2 percent target, and is actually drifting lower, while unemployment, though down from crisis peaks, remains stubbornly high.
Vincent Reinhart, Morgan Stanley’s chief U.S. economist and a former senior official at the Fed’s Board, even used the dreaded d-word in his latest research note to clients.
With evidence building that the Q2 soft patch is upon us, worrisome chatter about deflation is taking center stage. Our outlook for some time has been that mounting fiscal drag would show through in Q2 most strongly as sequester effects take hold and a slowdown in global trade hits U.S. shores. Indeed, another run of poor data this week has shown spring growth may be dampened by weakness in manufacturing, increasing jobless claims, and a stalling housing recovery. The slowdown in activity is not helping the Fed with their consistently significant misses on the employment side of their mandate, but it now appears they may have to turn their attention to supporting inflation from the bottom.