Federal Reserve officials stressed on Friday the importance of keeping close watch on inflation expectations as a way to keep inflation in check and keep track of trends in the economy.
Understanding expectations of all kinds are vital to successful conduct of monetary policy, Fed Vice Chairman Donald Kohn said at a conference on monetary policy, organised by the University of Chicago and Brandeis University.
Kohn's comments came in response to a paper suggesting central bankers place too great an emphasis on what rates of inflation markets, businesses and households plan for. Expectations are not always a good sign of inflation trends, the paper's authors said.
But Kohn disagreed. "Inflation expectations are critical: increases in expectations of inflation elevate the cost of returning to price stability," he said. "And un-anchored expectations make it very difficult to understand where the economy is and where it is going," he added. Richmond Fed President Jeffrey Lacker, a policy-maker who has advocated higher interest rates, said at the same conference that he believes inflation expectations may not be anchored enough to promote price stability.
Noting that market participants place some probability on core inflation remaining near current levels of 2.25 percent rather than moderating to 1.5 percent, Lacker said: "In that sense, one might question whether inflation expectations are anchored closely enough to the price stability shore."
Lacker, who dissented in the central bank's recent decisions to hold interest rates steady at 5.25 percent - preferring a quarter-percentage point rate rise - is no longer a voting member of the Fed's policy-setting committee.
Even so, the Fed as a whole clearly lays great store in keeping inflation expectations contained, and has cited continued stability of inflation expectations as a reason why it expects higher-than-desirable levels of core inflation to come down.
The Fed next meets March 20-21, and most observers expect the US central bank to hold rates steady at least one more time to put lingering concerns about inflation to rest. Hiring in the United States in January was roughly in line with modest expectations, government data released on Friday showed, easing some worries that had been building after stock market declines last week that the economy was weaker than previously believed.
Separately, a Reuters poll on Friday indicated that Wall Street expects the US Federal Reserve to keep benchmark short-term interest rates on hold for some time but leans strongly toward the bank's next move being a rate cut.
Some of the worries about softness in the economy stem from concerns that defaults among mortgages made to borrowers with blemished credit might cause wider turbulence among lenders. Fed Governor Susan Bies said in Charlotte, N.C. on Friday that the US central bank is well aware of troubles in the subprime market and has been monitoring the sector for the last several months.
Meanwhile, discussing the impact of global market integration on Fed policy at the same conference as Kohn and Lacker, Minneapolis Federal Reserve Bank President Gary Stern said the effects on long-term interest rates from Fed short-term rate hikes could be offset by financial inflows from abroad.
In addition, Fed Governor Randall Kroszner told the gathering that deregulation and financial globalisation have led to competition among currencies and contributed to keeping long-term interest rates down.