Banking

The economy is improving and will likely continue to do so, Atlanta Fed President and CEO Dennis Lockhart said in a March 7, 2011, speech in Arlington, Va.

His outlook for the economy and inflation calls for a "sustained pace of growth in the range of 3 to 4 percent," he said, with inflation trending closer to the level the Federal Open Market Committee (FOMC) considers consistent with the Fed's mandate—an annual rate of about 2 percent. Employment, meanwhile, will gradually improve over the next one to two years, he said.

According to Lockhart, the balance of risks has shifted somewhat with the recent unrest in the Middle East and North Africa, which has affected oil prices. Indeed, "seemingly distant developments can connect via unforeseen linkages and compound a shock or downside trend," he said. Nonetheless, he forecasts continuing improvement in the economy, "but with concern about growth downsides and price upsides."

Different tools, same framework
Looking ahead to his policy advice over the next couple of years, Lockhart will be using the same rules-based framework the FOMC has used for the past decade or so to decide changes in its key policy tool, the federal funds rate. In essence, this framework relates policy decisions, such as lowering or raising the fed funds rate, to "forecast 'misses' on the Fed's sustainable growth and stable inflation objectives," he explained.

Although the committee has been using nontraditional tools—asset purchases, for instance—these decisions were made using the same framework, he said. "It is within this framework that I think about the desirability of both LSAP3 [a third round of large-scale asset purchases] and the inevitable exit to a less accommodative policy stance."

The Fed's forward-looking framework depends on forecasts, "which by nature are shaped with a somewhat cloudy crystal ball," noted Lockhart. Among other indicators, he'll be looking for signs that economic activity, employment growth, and falling unemployment are on track. Most importantly, he'll be watching for emerging price pressures, he said.

Fed independence still key to monetary policy
In closing, Lockhart reminded the audience that the FOMC under former Chairman Paul Volcker took extraordinary measures to bring down high inflation. However, Volcker was able to take those steps only because the Fed's independence was respected. The FOMC today again faces new and extraordinary circumstances, which means that "Fed independence on monetary policy remains an essential feature of sound economic policymaking now as before."

March 30, 2011