By Pedro Nicolaci da Costa
FRANKFORT, Kentucky (Reuters) - The low U.S. inflation rate does not necessarily mean the economy is at high risk of a troubling downward price spiral, Richmond Federal Reserve Bank President Jeffrey Lacker said on Friday.
Lacker made the comments just three days after the Fed for the first time explicitly stated core inflation was running "somewhat below" levels at which policymakers are comfortable.
Low inflation may be seen as a harbinger of deflation, a downward price spiral that can cause consumers and businesses to put off purchases, dragging down the economy.
Lacker, an inflation hawk, said, however, he was not worried about deflation.
"I don't see the risk of an outbreak of deflation as very high at all right now," Lacker told reporters after a speech. "It's quite possible for inflation to run between 1 percent and 1-1/2 percent for quite some time without us spiraling into deflation."
Lacker's position suggests Fed Chairman Ben Bernanke will have his work cut out for him in nurturing unanimity within the central bank if he decides the U.S. economy is weak enough to warrant further monetary easing.
Bernanke himself did not directly address monetary policy in remarks prepared for delivery at Princeton University, where he headed the economics department before joining the Fed. He said only that the recovery was so far too weak to drag down the jobless rate.
"Although financial markets are for the most part functioning normally now, a concerted policy effort has so far not produced an economic recovery of sufficient vigor to significantly reduce the high level of unemployment," he said.
His speech focused on areas he considered ripe for economic study in the aftermath of the financial crisis.
Even though economists and policymakers failed to predict the financial crisis, "calls for a radical reworking of the field go too far," Bernanke said.
CONSTRAINING THE BALANCE SHEET
With interest rates already effectively at zero, the Fed is debating ramping up its purchases of longer-term debt in order to bring rates even lower and spur lending in an economy that is still sputtering along at a subpar pace.
Lacker did not appear to think a double-dip recession was a major risk, saying he expected growth to average about 2 percent on an annualized basis in the second quarter and then accelerate next year. However, he also said he expects the U.S. unemployment rate, currently at 9.6 percent, to come down only slowly.
Most Fed officials want to shoot for an inflation rate in the 1.7 percent to 2 percent range, although Lacker said he preferred it at a somewhat lower 1.5 percent.
The Fed's preferred core price gauge was up 1.4 percent in the 12 months through July, although the more popular core consumer price index has been running at just 0.9 percent. Fed officials look at core prices to get a sense of the underlying inflation trend.
The Fed has already bought $1.7 trillion in mortgage-related and Treasury debt. It said after its meeting on Tuesday that it was prepared to offer more support for the economy if needed to support the recovery and lift inflation.
Many market analysts expect the U.S. central bank will end up expanding its balance sheet further, with many looking for a move at the Fed's next meeting on November 2-3.
Charles Plosser, president of the Philadelphia Fed, told a conference in Switzerland that he believes there should be limits to how big the Fed's balance sheet can get.
"My view is that without explicit constraints on the size of the balance sheet, the Fed runs the risk of being pressured to use its balance sheet to engage in policies whose goals have nothing to do with monetary policy," said Plosser, who is also an inflation hawk.
Constraints would help the Fed maintain its independence and inflation-fighting credibility. It would "give the central bank a mechanism for saying no to fiscal authorities who may want to use the central bank's balance sheet to achieve other objectives," Plosser said.
Plosser, who joins the ranks of voting Fed policy makers next year, did not address the outlook for monetary policy or the economy. Lacker does not join the voting rotation until 2012.
