Fed’s Kohn on Interactions Between Monetary and Fiscal Policy

Federal Reserve Vice-Chairman, Donald Kohn, said Saturday in a conference at Princeton University in New Jersey, that the U.S. economy might be showing some signs of stabilization, but that the target federal funds rate is anticipated to remain near zero for some time given the expected weakness of the eventual recovery.

From the Fed:”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,” Kohn told the conference.

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,” he said, referring to the Fed’s policy-setting Federal Open Market Committee. 

Mr. Kohn also said that asset purchases of government and mortgage debt by the central bank may give a $1 trillion boost to the economy in coming years, along with $175 billion in extra tax revenue.

“Although any calculation of the effect of our asset purchases on the economy is highly uncertain, estimates from our models suggest that nominal GDP could be as much as $1 trillion higher over the next several years than it would be without the large-scale asset purchase program.”

Kohn defended the central bank’s nontraditional policy measures to the financial crisis while saying the central bank needs a framework for managing its balance sheet when it is time to move to contain inflation pressures when the economy rebounds. Some economists, including Philadelphia Fed President Plosser, say adding the assets to the balance sheet risks spurring inflation.

“The preliminary evidence suggests that our program so far has worked ; for example, our announcements regarding the large-scale asset purchase program coincided with cumulative restraint on the average level of longer-term interest rates,” Kohn…said.

Kohn concluded by saying that “changing policy interaction and greater cooperation between fiscal and monetary authorities have been an inevitable aspect of effective policy initiatives to meet our macroeconomic objectives in the current financial and economic crises. As the economic recovery takes hold, we will need to return to more normal modes of operation–a circumstance this central banker is very much looking forward to.”

Kohn’s full speech available here »

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