Financial Update (Fourth Quarter 2007)

Lockhart: Balance of Risk Has Shifted to Slower Growth

Dennis LockhartRecent volatility in financial markets shifted the balance of economic risks from higher inflation toward slower growth, according to Atlanta Fed President and Chief Executive Officer Dennis P. Lockhart.

"While inflation is currently at the upper bounds of my comfort zone, the Fed has made progress against it," Lockhart said during late September remarks at Middle Tennessee State University's Economic Outlook Conference in Murfreesboro, Tenn. "That's why I believe the recent moderation of inflation readings allowed a tactical move to reduce risks to the general economy with a fed funds rate cut."

Lockhart's talk centered on recent uncertainty in the economy and financial markets and his decision making process for recommending actions on monetary policy leading to the Sept. 18 Federal Open Market Committee (FOMC) meeting. At that meeting, the FOMC lowered the fed funds rate by half a percentage point.

Broader economic concerns influenced thinking
Lockhart said he considered the financial turbulence and the Fed's policy actions in the broader context of the potential for economic weakening. He referred to moral hazard—the possibility that an outside intervention might increase risk taking behavior—but ultimately decided that the overall financial system's well-being was the prime policy making consideration.

Text of speech
Lockhart bio
Sept. 18 FOMC statement off-site image

"I did not see the logic of subordinating the general welfare of our nation's economy to the possibility that some participants in financial markets might draw tainted conclusions about the future landscape of risk," he said concerning the Sept. 18 rate cut.

He referred to the Federal Reserve's primary purposes of financial stability, price stability, long-run economic growth, and maximum employment. "My view is that fulfilling the Fed's institutional purposes takes precedence," he said.

Housing merits continued scrutiny
Regarding the economic outlook, Lockhart cited housing, consumer spending, and business investment as factors that bear close attention. He said the protracted housing slump has probably hurt consumer spending, which represents about two-thirds of U.S. gross domestic product. If the housing downturn intensifies, he said that consumer spending could further weaken "related to slower home equity extraction and reduction in overall household wealth."

Moreover, Lockhart believes that financial conditions will continue to improve following actions of the Fed and other central banks. "Time has a healing quality, and I believe the healing process will be supported by further disclosure, more rigorous risk evaluation, and a more deleveraged financial reality," Lockhart said. "Of course, more financial volatility is possible, so I'll be watching this area closely."

October 11, 2007