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Fed must act now to boost economy, Evans says

Chicago Federal Reserve Bank President Charles Evans attend a dinner function at a hotel in Hong Kong
Chicago Federal Reserve Bank President Charles Evans attend a dinner function at a hotel in Hong Kong

By Ann Saphir

MUNCIE, Indiana (Reuters) - The Federal Reserve must take immediate action to inject new life into a moribund U.S. recovery or risk letting the nation settle into a permanently lower growth path, a top Fed official said on Monday.

"There is simply too much at stake for us to be excessively complacent while the economy is in such dire shape," Chicago Fed President Charles Evans told the Ball State University Center for Business and Economic Research. "It is imperative to undertake action now."

Evans' renewed call for monetary policy easing came even as the U.S. unemployment rate tumbled to a two-and-a-half-year low, and a variety of economic data suggest that U.S. economic growth may rise sharply this quarter, topping a 3 percent annual rate.

Known for his dovish views on inflation, Evans was the only Fed policy maker to dissent last month on the central bank's decision to leave monetary policy unchanged. Then, as today, he called for further easing to boost the recovery.

Since then, the U.S. unemployment rate has fallen from 9 percent to 8.6 percent, and data from manufacturing to retail sales suggest the pace of U.S. economic growth pace could accelerate from the second quarter's 2-percent annual rate.

Worries over a potential shock from the European debt crisis and likely fiscal tightening next year threaten that outlook, but Evans mentioned neither scenario in his speech.

Instead, he kept his focus on domestic monetary policy.

The U.S. central bank has "clearly" missed on its mandate to foster maximum employment and is in danger of undershooting its 2 percent inflation goal for the foreseeable future, Evans said.

Without new monetary stimulus, Evans warned, the U.S. could become mired in a 1930s-like depression, impairing economic growth permanently as the skills of the unemployed atrophy and businesses defer new investment.

To avoid such a scenario, Evans argued, the Fed should promise to keep interest rates near zero as long as unemployment remains "somewhat above its natural rate," so long as inflation does not threaten to rise above 3 percent.

While 3-percent inflation may sound "shocking," he said, research shows that central banks should fight liquidity traps by allowing inflation to run above target over the medium term.

Since high U.S. unemployment is probably due to the effect of a liquidity trap rather than a structural shift in the economy, Evans said, added monetary stimulus is justified.

And if it turns out, he said, that the real problem was indeed structural and easier monetary policy sparks a rise in inflation, the Fed can simply tighten policy before it threatens to reach the hyperinflationary levels of the 1970s.

"We would also know that we had made our best effort," he said.

Unemployment fell to 8.6 percent in November, and most estimates of the natural rate of unemployment hover around 5 percent to 6 percent.

The audience of several hundred entered the large convention center where Evans spoke under the watchful eyes of half a dozen armed members of the county sheriff's department, who were on site because of a threatened demonstration by Occupy Muncie.

Evans had previously suggested setting the unemployment trigger for monetary policy tightening at 7 percent but did not mention any specific figure in his prepared remarks on Monday.

The Fed's policy-setting panel meets next week to discuss what, if any, action to take to boost the economy. While many Fed officials appear to support some change in Fed communications, only a few have said they would support Evans' proposal.

Next week will be the last time Evans votes on the panel until 2013.

(Editing by Chizu Nomiyama and Padraic Cassidy)

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