Narayana Kocherlakota addressed the Minnesota Bankers Association yesterday, in his first public speech since taking over as president of the Minneapolis Fed last October. Kocherlakota said a “nascent recovery is under way,” and he expects the recovery to continue with 3 percent growth over the next two years. He characterized his forecast as a little more pessimistic than the FOMC’s, which expects growth of 3 percent this year and 4 percent next year.
Political uncertainty is a factor in his lower forecast:
“There is a great deal of political uncertainty related to major policy initiatives underway in Washington. Congress is considering proposals for enormous changes in health care and in the structure of financial regulation…[and] the capricious winds of politics seem to change them on a near-daily basis.”
Kocherlakota expressed concern about the nation’s unemployment rate and discussed scenarios that could cause inflation to rise:
“Deposit institutions are holding over a trillion dollars of excess reserves (that is, over 15 times what they are required to hold given their deposits). These excess reserves create the potential for high inflation. Suppose that households believe that prices will rise. They would then demand more deposits to use for transactions…these extra deposits become extra money chasing the same amount of goods and so generate upward pressure on prices.”
He hastened to add, and to emphasize, that he did not expect high inflation to set in:
“We would need a combination of bad monetary policy and poor fiscal management. I do not foresee this combination as likely to occur.”
Kocherlakota waded into the debate about limiting the Fed’s supervisory role, saying that its firsthand knowledge of banks helped the Fed react to the financial crisis. Kocherlakota said the Fed “has every incentive to do a good job in assessing the borrower quality” before extending a loan through the discount window or programs like the Term Auction Facility; if the loan goes bad the loss is on the Fed’s balance sheet.
“Suppose instead that some other agency were responsible for providing this information to the Federal Reserve. What exactly are this other agency’s incentives to provide…the best possible information? This other agency is not going to suffer a loss for making a bad loan–the Federal Reserve is.”
He also noted that the Fed’s supervisory experience gave it the scope to conduct last year’s stress tests of the country’s 19 largest banks, something no other “institution in the government would have the kind of collective expertise to orchestrate.”
