Fed's Kocherlakota: Tough central banks can control prices

CHICAGO Mon Sep 26, 2011 3:03pm EDT

CHICAGO (Reuters) - Central bankers can control inflation regardless of fiscal policy, but only if they are willing to allow the government to default, Minneapolis Federal Reserve President Narayana Kocherlakota said on Monday.

"A sufficiently tough central bank does have the ability to control the price level, regardless of the behavior of the fiscal authority," Kocherlakota said in remarks prepared for delivery to a sovereign debt seminar at CME Group Inc's Chicago headquarters.

The seminar was held in conjunction with the CME Group-MSRI Prize in Innovative Quantitative Applications, and Kocherlakota said he was not commenting about any particular country's policies.

Irresponsible fiscal behavior tends to push up inflation, Kocherlakota said. But if central banks hold the line, to the point of letting fiscal authorities default if necessary, they will be able to control inflation, he said.

Such an approach may not always be the best one, Kocherlakota said.

"It may be optimal for central banks to guarantee fiscal authority debts in some situations," he said, to avoid exposing the country to severe short-term and medium-term losses in output.

If this is the approach taken, he said, then "we again have to think of price level determination as something that is done jointly by the fiscal authority and the central bank."

Kocherlakota did not make any reference in prepared remarks to the Fed's latest easing move, or his dissent against it, earlier this month.

A budget impasse over the summer brought the United States to the verge of a first-ever debt default. Although a last-minute agreement averted that, uncertainty over fiscal policy has unsettled consumers and contributed to an economic slowdown.

Fed officials, including Chairman Ben Bernanke, have called on policymakers to forge a long-term fiscal solution, but politicians have continued to spar over what course to take.

(Reporting by Ann Saphir; Editing by Padraic Cassidy)

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