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Fed president sees possible rate hike in 2011 as economy slowly improves

Narayana Kocherlakota
Narayana Kocherlakota

Minneapolis Federal Reserve Bank President Narayana Kocherlakota forecast continued economic improvement in 2011 and repeated a call for an increase in the Federal funds target rate of as much as half a percentage point, to keep inflation in check.

Speaking before the Rochester Chamber of Commerce this week, Kocherlakota laid out his views on economic growth, unemployment and inflation. “My bottom line is that, from the point of view of the macroeconomy, 2011 will be a better year than 2010,” he told the group.

Kocherlakota sits as a voting member on the Federal Open Market Committee, which sets the rate banks pay to borrow money overnight and is used by the Fed to attempt to control inflation. The current target rate is between zero and 0.25 percent. Kocherlakota said he could see increasing that by an additional 0.5 percent by the end of the year.

From the fourth quarter of 2009 to the fourth quarter of 2010, core inflation on a bundle of consumer goods and services tracked by the government, was 0.8 percent. That is the lowest annual inflation rate in 50-plus-year history the government has tracked that number, Kocherlakota said.

But he expects that to pick up to 1.5 percent over the remainder of 2011, just below the Fed target inflation rate of 2 percent.

The U.S. economic recovery slowed in the first quarter of this year, Kocherlakota said, as gross domestic product growth fell to a 1.8 percent annual rate, the lowest growth since the Great Recession ended. GDP growth reached 2.9 percent for all of calendar 2010, up from a negative 2.6 percent drop in 2009. The Fed president is forecasting GDP growth of around 3 percent for the full year, slightly below a consensus of economic forecasts.

“Given the depth of the recession that we experienced, this rate of growth is disappointing,” he said.

Kocherlakota said the economic recovery will be slowed two factors. Individuals trying to repair their household balance sheets will spend less and save more, putting a drag on the consumer sectors. He also said that even as the economy gets better, increasing loan demand, the significant number of banks holding delinquent mortgage or commercial loans will slow lending activity.

Finally, Kocherlakota projected the U.S. unemployment rate “is likely to be still close to 8.5 percent by the end of the year,” down slightly from the 9.0 percent reported for April.

He said that the slow decline in the unemployment rate is the result of two competing forces: As the improving economy generates more jobs, workers previously sitting out of the job market will begin looking for work.

Longer term, he said he expects the unemployment rate “to normalize at close to 5 percent within the next five years.”

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