Here are comments from a U.S. Treasury official on Secretary Jack Lew’s meeting with incoming Acting IRS Commissioner Daniel Werfel this morning, following a scandal of political targeting that cost the previous acting commissioner his job. Treasury officials knew about the problem as early as last June, according to this report in the Wall Street Journal:

Secretary Lew met with incoming Acting IRS Commissioner Werfel this morning and directed him to conduct a thorough review of the organization in an effort to restore public confidence in the IRS and ensure the organization is providing excellent and unbiased service to the taxpayer. Secretary Lew also requested that he take actions immediately as appropriate, and that within the next 30 days, Werfel report back to the President and him about progress made in three areas: 1) ensuring staff that acted inappropriately are held accountable 2) examine and correct any failures in the system that allowed this behavior to happen and 3) take a forward-looking systemic view at the agency’s organization.

In the barrage of Federal Reserve speakers making the rounds on Thursday, it is notable that San Francisco Fed President John Williams was the one that managed to move markets, allowing the dollar to recover losses. Why did his voice rise above the din? For one thing, he’s seen as a dovish-leaning centrist whose views closely resemble the Bernanke-Yellen core of the central bank.

Plus, he took the oft-abused economy-car analogy in a, er, new direction:

If we were in a car, you might say we’re motoring along, but well under the speed limit. The fact that we’re cruising at a moderate speed instead of still stuck in the ditch is due in part to the Federal Reserve’s unprecedented efforts to keep interest rates low. We may not be getting there as fast as we’d like, but we’re definitely moving in the right direction.

Richard Fisher, the Dallas Fed’s outspoken president, is happy to be labeled a monetary policy hawk. After all, he sometimes quips, “doves are part of the pigeon family.” That may be so. But thus far, the doves have had the upper hand in the policy debate – and the economic data appear to bear them out.

Fed hawks like Fisher have warned that the U.S. central bank’s prolonged policy of low interest rates and asset purchases risks a future spike in inflation. Yet despite the Fed’s aggressive efforts, inflation is actually drifting lower, not higher, suggesting there is something to the dovish notion that there is still ample slack in the U.S. economy following a lackluster recovery from the historic slump of 2007-2009.

Regional Fed hawks tend to argue that the Fed should not overreach in its efforts to bring down unemployment because the only thing it can really control in the long-run is inflation. Says Jeffrey Lacker, president of the Richmond Fed:

In contrast to inflation, which over time is determined by central bank actions, real economic growth and labor market conditions are affected by a wide variety of factors outside a central bank’s control.

So what should we make of the recent decline in the Fed’s preferred measure of inflation to just around half of the central bank’s 2 percent target. Has the Fed lost its ability to influence consumer prices, or is it just not trying hard enough?

Justin Wolfers, economist at the University of Michigan, thinks it’s more the latter:

They say that they’re going to set monetary policy in a way that ensures future inflation will be 2.0 percent. Right now, they expect it to be lower than that, and unemployment to be unconscionably high, so the Fed’s own framework says that they need to take more stimulative action.

Lacker, however, told reporters on Wednesday he believes the decline will be transitory given relatively stable inflation expectations.

The Fed cut official interest rates to effectively zero in late 2008, and is on track to buy over $3 trillion in Treasury and mortgage bonds. Despite those actions, its favored inflation gauge, the Personal Consumption Expenditures (PCE) price index, has fallen to a 3-1/2 year low of 1.0 percent. And according to the Fed’s own forecasts, inflation is likely to remain short of the central bank’s target for years.

Meanwhile, unemployment, while down considerably from its crisis peak of 10 percent, remains historically elevated at 7.5 percent, with long-term joblessness a particularly acute concern.

“When you look at housing market conditions, I think you could make the case that we should be getting out of mortgage-backed securities,” Lacker told reporters after a speech.

Lacker, an inflation hawk who has consistently opposed mortgage-backed securities purchases by the central bank, said the process of getting out of the market could be initiated by reinvesting the principal from maturing mortgage bonds into the Treasury market.

After slashing official interest rates to effectively zero in late 2008, at the height of a global financial crisis, the Fed is on track to buy over $3 trillion in securities in an effort to bolster an anemic recovery.

While he admitted that the recent growth record had been disappointing, Lacker said a 2 percent growth rate was pretty good considering all the challenges facing the economy.

Asked about a recent decline in inflation to around half the Fed’s 2 percent target, Lacker said the dip was likely transitory. He said he was not worried about adverse reaction on Wall Street from an eventual curtailing of the Fed’s asset purchases.

The Fed said earlier this month it could either boost or reduce its current monthly pace of $85 billion in asset buys.

“I don’t see any effective constraints on our ability to reduce the pace of asset purchases without undue market reaction,” Lacker said following an economic outlook speech that largely echoed remarks made on May 3.

U.S. economic growth continues to sputter along in fits and starts, rebounding to a 2.5 percent annual clip in the first quarter following a very weak end to 2012. The jobless rate has come down from a crisis peak of 10 percent in late 2010 to its current 7.5 percent. The Fed pledged in December to keep buying bonds until it saw substantial improvement in the outlook for U.S. employment.

Lacker said he was not worried about the threat of higher inflation for now, but believes the Fed’s unconventional policy measures raise the risk of quicker price growth down the line.

“Inflation doesn’t take care of itself – it requires some attention from a central bank,” he said. “The inflation outlook looks good now, but I think there are risks to the inflation outlook a couple of years ahead of us.”

(Editing by Leslie Adler and Peter Cooney)

Evidence that Europe’s austerity policies are not working was in ample supply this morning. The euro zone as a whole is now in its longest recession since the start of monetary union. France has succumbed to the region’s retrenchment. Italy’s GDP slump is now the lengthiest on record. And Greece, still in depression, shrank another 5.3 percent in the first quarter.

To understand why this is happening, Brown University professor Mark Blyth says it is necessary to forget everything you think you know about the euro zone crisis. The monetary union’s troubles are not, as often depicted, the result of runaway spending by bloated, profligate states that are finally being forced to pay the piper. Instead, argues Blyth, it is merely a sequel to the U.S. financial meltdown that started, like its American counterpart, with dangerously-indebted risk-taking on the part of a super-sized banking sector.

In a new book entitled “Austerity: The history of a dangerous idea,” Blythe writes that sovereign budgets have come under strain primarily because taxpayers of various nations have been forced to shoulder the burden of failed banking systems.

The way austerity is being represented by both politicians and the media – as the payback for something called the ‘sovereign debt crisis,’ supposedly brought on by states that apparently ‘spent too much’ – is a quite fundamental misrepresentation of the facts. These problems, including the crisis in the bond markets, started with the banks and will end with the banks. The current mess is not a sovereign debt crisis generated by excessive spending for anyone except the Greeks. For everyone else, the problem is the banks that sovereigns have to take responsibility for, especially in the euro zone. That we call it a ‘sovereign debt crisis’ suggests a very interesting politics of ’bait and switch’ at play.

So why all the misunderstanding? Why has the crisis become conflated with a government debt problem in the public imagination? According to Blythe, this is a convenient way for Wall Street to again saddle the state with massive banking sector losses.

The cost of bailing, recapitalizing, and otherwise saving the global banking system has been, depending on how you count it, between 3 and 13 trillion dollars. Most of that ended up on the balance sheets of governments as they absorb the costs of the bust, which is why we mistakenly call this a sovereign debt crisis when in fact it is a transmuted and well-camouflaged banking crisis.

The Fed cut official interest rates effectively to zero in late 2008 during the financial crisis. Since then, it has bought more than $2.5 trillion in bonds to bolster an anemic economic recovery and speed up the decline in unemployment.

Despite those actions, its favored inflation gauge, the Personal Consumption Expenditures (PCE) price index, has fallen to a 3-1/2 year low of 1.0 percent.

Further, by the Fed’s own forecasts, inflation is likely to remain short of the central bank’s target for years.

“They say that they’re going to set monetary policy in a way that ensures future inflation will be 2.0 percent,” said Justin Wolfers, an economics professor at the University of Michigan’s Gerald Ford School of Public Policy.

“Right now, they expect it to be lower than that, and unemployment to be unconscionably high, so the Fed’s own framework says that they need to take more stimulative action.”

That could happen, if the drop in inflation persists.

“I’m very willing to defend the inflation target from the low side. If we say 2.0 percent, we should hit 2.0 percent,” St. Louis Federal Reserve Bank President James Bullard told reporters last month.

COMFORT IN OTHER MEASURES

For now, however, Fed officials do not view the decline as a signal of a worrying deflationary threat.

At its policy meeting last week the central bank decided to continue with its $85 billion a month in bond purchases, and a statement announcing the decision offered no hint of panic.

In its statement the Fed stuck with a characterization of inflation as “running somewhat below” its target, a phrase it had been employing since December.

Officials have taken solace in the relative stability of inflation expectations, which are seen as a leading indicator of actual inflation.

The spread between Treasury notes and inflation-linked bonds, a measure of investors’ inflation perceptions, has eased gradually this year to its lowest levels since last autumn. But it is still far above the lows seen in 2012, before the Fed launched its latest and third round of bond buying or “quantitative easing”.

Indeed, a daily deflation probability gauge produced by the Atlanta Federal Reserve Bank that is based on bond market measures currently reads zero, a level unchanged since February.

Policymakers can also take some comfort from a growing gap between the inflation gauge they target and the more popular consumer price index. CPI inflation has been running at much higher rates which may suggest the decline in the PCE price index will prove transitory and turn around if economic growth picks up as expected towards the end of 2013.

While the PCE price index rose just 1.0 percent in the year through March, and its core counterpart was up just 1.1 percent, the CPI was up 1.5 percent and the core CPI climbed 1.9 percent. It is the biggest gap between the two core measures in a decade.

“The Fed may view the divergence between the two measures as indicating that worries about deflation are premature,” said Tim Duy, a professor of economics at the University of Oregon. “If core CPI was trending down as well, the Fed would be more likely to conclude that their inflation forecasts should be guided lower.”

EVERYWHERE AND SOMETIMES

The difference between the two indexes has been driven by trends in home and food prices, and differences in methodology.

The CPI uses a fixed basket of goods while the PCE price index allows for the prospect that consumers substitute goods as one product gets pricier – coffee versus tea is an example.

There are also differences in the way the two indexes define food. For example, the PCE price index includes food services in its core index. So a recent slowing in food services costs has affected the core PCE price index but not the core CPI index.

Housing, which plays a much bigger role in the CPI, is also a big factor. When home prices slumped between 2006 and 2012, CPI inflation dropped below PCE inflation but now the opposite is happening.

An array of signs showing economic growth slowing sharply as the first quarter 2013 drew to a close raised some alarm bells, and helped to squelch talk at the Fed about the bond purchase program.

Yields on the benchmark 10-year U.S. Treasury note slipped from just over 2.0 percent in March to a four-month low of 1.63 percent last week as investors’ concerns on growth increased.

But a report on Friday showing employment growth running higher than expected, despite a tighter fiscal policy in Washington, helped temper any fears of a deflation risk and the 10-year yield has moved back up to 1.78 percent.

“I do not see a deflation threat in other inflation-related data like labor costs and inflation expectations, so that makes it less likely to cause concern,” said Jim O’Sullivan, chief U.S. economist at High Frequency Economics.

The late monetarist economist Milton Friedman famously argued that inflation is “everywhere and always a monetary phenomenon.”

But the current period of sub-target inflation is a reminder that other factors, like the federal budget, help determine how much money makes it into the real economy.

If economic growth picks up later this year as the impact of austerity in Washington fades, as many economists expect, than the Fed’s inflation gauge is likely to follow.

(Additional reporting by Alister Bull; Editing by Tim Ahmann and Clive McKeef)

But policymakers are not there yet.

At a two-day meeting that wraps up on Wednesday, the Fed is widely expected to maintain its monthly purchases of $85 billion in bonds to support an economic recovery that is nearly four years old but still too weak for the job market to truly heal.

With the central bank’s favored inflation gauge slipping and employment growth faltering, Fed officials could again find themselves in the uncomfortable position of having to shift from talk of curbing stimulus to the possibility of doing more.

Currently, analysts see the Fed buying a total $1 trillion in Treasury and mortgage-backed securities during the ongoing third round of quantitative easing, known as QE3. Until recently, analysts had believed the Fed would start taking the foot off the accelerator in the second half of the year.

Now, things are looking a bit more shaky.

The housing market continues to show signs of strength, with home prices posting their biggest yearly gain since 2006, the year the market began a historic slide that snowballed into a global financial crisis.

However, the industrial sector is not quite as perky. Durable goods orders posted their largest drop in seven months in March, while an index of Midwest manufacturing showed an unexpected contraction in the sector for April.

Economic growth did rebound in the first quarter after a dismal end to 2012, but the 2.5 percent annual rate of expansion fell short of economists’ estimates, and economists are already penciling in a weaker second quarter.

At the same time, inflation has steadily been coming down. The Fed’s preferred measure of core inflation, which excludes more volatile food and energy costs, rose just 1.1 percent in the year to March. Overall inflation was up just 1 percent, the smallest gain in 3-1/2 years.

The Fed targets inflation of 2 percent.

CHECKING THE TOOLKIT

Despite the economy’s softer tone, a wait-and-see attitude seems the most likely approach for now. The Fed is expected to nod to the economy’s disappointing performance when it announces its decision at 2 p.m. (1800 GMT), even as it maintains its course.

But if the economy’s fortunes do not improve, the U.S. central bank may well look for fresh ways to boost its support to the economy — increasing the amount of assets it is buying is just one option.

The Fed could announce an intent to hold the bonds it has bought until maturity instead of selling them when the time comes to tighten monetary policy. Fed Chairman Ben Bernanke has already raised this as a possibility.

U.S. central bankers could also set a lower unemployment threshold to signal when the time might be ripe to finally raise overnight interest rates, which they have held near zero since December 2008. Currently, the threshold stands at 6.5 percent, provided inflation does not threaten to breach 2.5 percent.

Research suggests such “forward guidance” about the future path of interest rates can have a strong impact on current borrowing costs, and one Fed official — Narayana Kocherlakota, president of the Minneapolis Federal Reserve Bank — has already suggested lowering the threshold to give the economy a boost.

“Forward guidance would be perceived as having lower costs (than bond purchases) by most, I think, and for that reason I think it could be the preferred avenue, especially if more stimulus was projected to be needed for a long period of time,” said Roberto Perli, a partner at Cornerstone Macro in Washington and a former Fed economist.

Analysts generally agree that is a debate for the future, if the Fed even gets there at all.

Victor Li, a former regional Fed economist who teaches at Villanova University in Pennsylvania, said employment growth would have to be consistently below the 100,000 jobs per month pace in combination with core inflation of around 1 percent for the Fed to consider a greater easing of monetary policy.

“There is just no evidence that this is going to happen.”

Others are less sanguine. Justin Wolfers, an economics professor at the University of Michigan’s Gerald Ford School of Public Policy, said the risk that prices will drop persistently, causing further economic damage, cannot be ruled out.

“What’s more relevant than the current inflation trend is what this means for forecast inflation,” Wolfers said. “And I think even more relevant than the Fed’s official point estimate for inflation is the probability that deflation looms as a real threat. Inflation rates lower than 1 percent certainly raise a greater risk of deflation.”

(Reporting by Pedro Nicolaci da Costa; Editing by Tim Ahmann and Leslie Adler)

With world food demand on the rise, growers in the Pampas
grains belt are filling their silos with soy rather than
converting their crops into pesos, a currency that hit a new
all-time low in informal trade this week.

Considering Argentina’s high inflation, clocked at about 25
percent by private economists, “money in the bank” is not as
secure as storing soybeans next to their fields, many say.

“We are going to hang onto our soy. One can see higher
prices ahead,” said Jose Plazibat, a partner with the firm of
Bandurria and Plazibat Brothers, which farms more than 3,000
hectares near the town of Chacabuco in Buenos Aires province.

South and North American growers remember that prices hit
record peaks during a drought in the United States last year and
they are holding out on prospects for another weather rally this
season.

Argentina is world’s No. 3 exporter of soybeans and
government officials, eager to get their hands on soybean export
revenue, have told growers to keep soy flowing into export
markets.

Cut off from global bond markets since its 2002 default,
Argentina needs farm revenue to help finance public spending
increases ahead of October legislative elections.

But Argentine grains are moving slower this year. The
Rosario grains exchange says farmers sold 26 percent of their
2012/13 soy as of April 10, way under the 46 percent registered
at the same point in the previous season.

UNEVEN YIELDS

The 2012/13 season started with widespread flooding in the
Pampas that slowed planting and it ended with a January-February
dry spell that pressured yields.

The government expects a soy crop of 51.3 million tonnes,
which is lower than original estimates. The agriculture ministry
says 38 percent of the 19.1 million hectares of soy planted this
season have so far been harvested.

“Yields are very irregular due to the uneven weather we had
at the beginning and end of this growing season,” said Juan
Solari, a partner at the Emidelia Solari farm near Chacabuco.

He estimated average soy yields in the region at about 3
tonnes per hectare and corn at about 10 tonnes per hectare.

Argentina is expecting a record-large 2012/13 corn harvest
of 25.7 million tonnes, thanks in large part to new genetically
modified technology that will improve yields. The agriculture
ministry says 43 percent of the 4.6 million hectares planted
with corn has been brought in to date.

Growers say they would plant more corn if the government
would stop placing curbs on exports. The farm sector has long
feuded with President Cristina Fernandez, who won re-election in
2011 on promises of increasing the government’s role in Latin
America’s No. 3 economy.

Confidence has since softened. The peso has slumped in the
informal market, opening a breach of 71 percent versus the
formal exchange rate and increasing market chatter about a
possible devaluation to shore up exports.

The government is likely to put off a devaluation of the
official peso at least until the October elections have passed.
On the black market, the peso hit a record low close on Tuesday
of 8.86 per U.S. dollar.

(Additional reporting by Sam Nelson in Chicago; Writing by Hugh
Bronstein. Editing by Bob Burgdorfer)

All the talk of currency wars is mostly just that – talk. This week’s meeting of the Group of 20 nations at the International Monetary Fund was living proof. Despite speculation that emerging nations would redouble their criticism of extraordinarily low rates in advanced economies, the G20 ended up largely supporting the Bank of Japan’s new and bold stimulus efforts aimed at combating years of deflation.

Mr. currency wars himself, Brazilian Finance Minister Guido Mantega, told reporters Japan’s monetary drive was understandable given its struggle with falling prices and stagnant wages, even if he called for close monitoring of its potential spillover effects.

Outgoing Bank of Canada Governor Mark Carney said Japan’s action is consistent with the G20 communiqué that called for countries to refrain from competitive devaluation. Carney, the head of the G20′s Financial Stability Board, takes over the Bank of England in July. His comments echo recent remarks from Fed Vice Chair Janet Yellen.

“It appears with Kuroda’s and Aso’s comments and the G20′s acceptance of their explanation on monetary policy that the path is clear for the BOJ to both continue easing or enact additional easing measures if needed,” said Brian Daingerfield, currency strategist, at RBS Securities in Stamford, Connecticut.