Fed vice chairman suggests letting inflation run for a while

What's one more year since 1913?

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Watch-and-Wait Is Best Policy for Oil Shocks: Kohn

By Greg Robb
MarketWatch.com
Wednesday, June 11, 2008

http://www.marketwatch.com/news/story/story.aspx?guid=%7B0404E150%2DF28F...

CHATHAM, Massachusetts -- Monetary policy should allow a temporary rise in unemployment and inflation to let an economy find its balance from an oil-price shock, Federal Reserve Vice Chairman Donald Kohn said on Wednesday.

"It may be efficient to allow some adjustment period in which both overall inflation exceeds its desired low level and the unemployment rate is higher than its long-run sustainable level ... setting policy in a manner that balances the undesirable effects of a shock to the system on both inflation and employment will tend to be more efficient than setting policy so as to deliver more extreme outcomes in either inflation or unemployment," Kohn said in remarks to a conference on inflation-dynamics sponsored by the Boston Federal Reserve Bank.

His remarks suggest a go-slow attitude at the Fed now that rates have been cut to 2% level.

Economists say high oil prices are a double-edged sword: reducing economic growth because consumers have to pay more of their disposable income for staples. At the same time, high oil prices put upward pressure on inflation.

Higher energy prices have also put upward pressure on public expectations on future inflation.

"Any tendency for these longer-term inflation expectations to drift higher or even to fail to reverse over time would have troublesome implications for the outlook for inflation," Kohn said.

His remarks echo Fed chairman Ben Bernanke's warning Monday evening that the Fed would not tolerate upward move in long-run inflation expectations.

At the same time, Kohn said recent history showed that oil price shocks have had only a modest impact on overall prices.

"A trend in any individual relative price should not, in itself, lead to a change in the desirable rate of inflation over the long run," Kohn said.

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