Fed's Kohn: Tightening Of Monetary Policy To Depend On Economic Forecasts

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Federal Reserve Vice Chairman Donald Kohn said Wednesday that a decision to tighten accommodative monetary policies would depend on economic forecasts, rather than current conditions.

Speaking at the Cato Institute's Shadow Open Market Committee Meeting in Washington, D.C., Kohn said that the central bank must begin to withdraw its accommodation "well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability."

He did say, however, that he could not provide a list of variables that would lead the Fed to begin an exit, instead saying that they would use all sources of information to determine when the exit would be warranted.

"Clearly, the present degree of accommodation--as gauged by nominal and real short-term interest rates and the size of our balance sheet--is extraordinary, and we will have to take account of how that is influencing spending and inflation expectations when deciding when and how fast to tighten." Kohn said in prepared remarks.

Kohn went on to say, as many Fed officials have in recent months, that the central bank has the tools to wind down current monetary policy when it is necessary, and he said that the Fed is developing new techniques to drain its reserves, including reverse repurchase agreements against mortgage-backed securities and time deposits for banks at the Fed.

"And, of course, we retain the option to sell securities from our portfolio on an outright basis," he added. "The range of tools will permit us to drain large volumes of reserves if necessary to achieve the policy stance that fosters our macroeconomic objectives."

Kohn also stressed the importance of effective communication between the Fed and the public about the central bank's assessment of economic conditions and its decisions regarding monetary policy.

"We will need to explain especially carefully--in our policy announcements, the minutes of our meetings, and our quarterly forecasts--the evolution of our assessment of the economic situation and the risks associated with achieving our goals," he said.

The vice chairman did conclude, however, by repeating Fed sentiment that the recovery will be slow due to credit restraints and that interest rates would remain low for an "extended period."

Federal Reserve Vice Chairman Donald Kohn said Wednesday that a decision to tighten accommodative monetary policies would depend on economic forecasts, rather than current conditions. Speaking at the Cato Institute, Kohn said that the central bank must begin to withdraw its accommodation "well before aggregate spending threatens to press against potential supply, and well before inflation as well as inflation expectations rise above levels consistent with price stability." (Market News Provided by RTTNews)