Fed Hoenig’s View on Interest Rates and Inflation

Federal Reserve Bank of Kansas City President Thomas Hoenig delivered a speech today in Sheridan, Wyo, where he reiterated  his stance on inflation and how that pressure, as he sees it, may compel the Fed to raise interest rates. Here are a few excerpts from his remarks:

Kansas Fed: Starting from where we are today, it is clear that interest rates must rise. As the economy recovers, even at a modest pace, resource demands will begin to increase. At this point, the current level of monetary accommodation will need to be withdrawn to avoid introducing inflationary impulses. Also, with the almost certain adjustments that need to occur in consumption, savings and the rebalancing of imports and exports, I expect there would be additional pressure for interest rates to rise steadily over time. To the extent that these adjustments will require considerable time to complete, unemployment levels, for example, may decline more slowly than anyone wants.

If such a set of events occurs, then I also suspect there will be considerable pressure on the central bank to “help out” in casing this adjustment process by keeping interest rates low for an extended period. This happens because people often confuse the establishment of low interest rates – and therefore the creation of money – with the creation of wealth. Sadly, through history, it has been shown repeatedly that excessive reliance on monetary policy as a means to avoid fundamental economic policy choices leads to high inflation and an actual worsening of an economy’s long-term performance. I hope the U.S. can avoid the temptation to take policy short cuts as we emerge from this recession.

Finally, the markets won’t be fooled by artificially low rates for long. Market participants realize that a period of high deficits and accommodative monetary policy are an invitation to increased inflationary pressure. I suspect we are experiencing the first signs of the markets’ concerns in the rising rates and increased volatility in longer-term Treasury markets. I suggest strongly that we need to be alert to the markets’ message and begin in earnest to bring monetary policy into better balance before inflation forces our hand.

emphasis added

Hoening also said that while he was “convinced the economic recovery we all want will develop, it will be slower and more fragile than we hope for.” His view on the economy is that it will emerge from the recession, perhaps as soon as the second half of this year, but most likely in early 2010.

Fed’s Hoenig dissented from a rate cut on Oct. 31 of last year because of his concern about inflation.

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