May 10, 2012 / 5:27 PM / 7 years ago

Fed's Kocherlakota: U.S. may be near full employment

MINNEAPOLIS (Reuters) - Unemployment may not have too much farther to fall before inflation threatens, forcing the Federal Reserve to respond by beginning its exit from super-easy monetary policy in six to nine months, a top Fed official said on Thursday.

Minneapolis Fed President Narayana Kocherlakota, whose policy views tend toward the hawkish end of the policy spectrum, said he sees inflation at about 2 percent this year - the Fed’s target - but rising to 2.3 percent next year.

If that forecast pans out, he said, the Fed’s policy-setting committee may soon need to change its current guidance that it will keep rates low through late 2014. The Fed has kept rates near zero since 2008.

“I continue to watch inflation very carefully, and not just because I’m concerned about price stability, but more because it’s a guide to how close we are to maximum employment as well,” Kocherlakota told reporters after a speech at the Economic Club of Minnesota.

“If the committee were to agree with my prognosis that we should be initiating exit in six to nine months, you would want to change language of that statement even sooner.”

Kocherlakota’s views are in the minority at the U.S. central bank.

Last month, after reiterating the Fed’s commitment to keep rates low for the next two and a half years, Fed Chairman Ben Bernanke described monetary policy as being in “more or less the right place,” and promised another launch another round of bond purchases if the economy were to weaken.

And though in recent months they have scaled back expectations for a new bond buying initiative, economists at major Wall Street firms surveyed on Friday still saw about a one in three chance the Fed will start another bond buying initiative.

GDP growth cooled to 2.2 percent in the first quarter from 3 percent in the final quarter of last year, and last Friday a government report showed U.S. employers added a surprisingly meager 115,000 jobs in April.

JOBS KEY TO POLICY

The debate over the true level of “maximum employment” in the United States is emerging as an important one as the Fed weighs its next policy move.

Some inflation hawks like Kocherlakota believe that structural changes in the economy since the Great Recession mean the unemployment rate may not decline to the levels that were typical before the crisis. They point to a rise in unfilled job openings that, they say, suggest workers’ skills do not match the current needs of employers.

On Thursday, Kocherlakota used some of his speech to examine the experience of Sweden in the 1990s, where unemployment rose sharply after a severe financial crisis and since then has never declined to pre-crisis levels.

“At a minimum, Sweden’s experiences forces us to contemplate the possibility that the erosion in the labor market performance that we’ve seen in the United States over the past five years may be highly persistent, even under appropriate monetary policy,” said Kocherlakota, who is not a voter this year on the Fed’s policy-setting panel.

Kocherlakota said he believes the U.S. economy in the long run can tolerate an unemployment rate of around 6 percent before inflationary pressures start building. But near-term, he said, that rate is probably “much closer” to the current 8.1 percent level.

Taking the opposite view is San Francisco Fed President John Williams, who argued recently that the jobless rate is still at least 2 percentage points above maximum employment. Such a view suggests the Fed can keep monetary policy extremely easy for quite some time before risking a rise in inflation.

But Kocherlakota on Thursday said he believes it’s at least possible that the erosion in the labor market may be “highly persistent” even with extremely easy monetary policy.

And “distinctly higher” inflation in 2011 versus 2010, he suggested, may force the Fed’s hand sooner than it now expects.

Reporting by Ann Saphir; Editing by Chizu Nomiyama

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