The Federal Reserve must stay focused in the longer term on maintaining the value of the U.S. dollar by holding down inflation, Kansas City Federal Reserve Bank President Thomas Hoenig said on Monday.

Speaking at an economic forum in Gering, Nebraska, Hoenig said it was important not to overreact to the turmoil in financial markets, capped by Monday’s record points fall for the Dow Jones industrial average.

“When I read and watch the news, I get a definite sense that the sky is falling,” Hoenig said. “But we need to take a deep breath and think about what is happening.”

The U.S. economy is “resilient,” and has weathered crises in the past.

It will emerge stronger from the current run of events, especially if certain much-needed structural changes start to take place, Hoenig said.

Hoenig is not a voting member of the Federal Open Market Committee, which sets benchmark interest rates, in 2008.

The Fed’s 10th district president said tumult over the past few days had not fundamentally changed his longer-term optimism about the U.S. economy,

Still, economic growth will likely be sluggish into 2009 as consumer spending is blunted by high energy costs and the housing market remains dogged by high inventories.

Exports remain a significant source of strength for U.S. growth, but could tail off in the face of weaker global growth, he said.

Despite risks to growth, Hoenig said the Fed cannot lose its focus on inflation, especially as recent high commodity prices work their way through to final product prices.

“Inflationary pressure is one of the concerns I have,” he said. “At 5.5 percent, (headline) inflation is too high, and will have a long-term impact on the economy.”

“I’ll be more anxious than others to reduce excess liquidity” and start raising interest rates when that is feasible, Hoenig said.

In response to a question, Hoenig said the Fed’s massive injections of liquidity into gummed-up money markets are not inflationary for now but risk an inflation bubble if not reversed in a timely fashion.

The central bank faces “a very delicate, difficult piece of surgery” to raise rates at the right time, Hoenig said.

The FOMC has set its fed funds rate at 2 percent since April, having lowered it by a total of 325 basis points from September 2007 to cushion the economy from the ravages of the financial crisis.

Financial markets now lean to a 50 basis point rate cut, to 1.5 percent, in October.

Source: http://www.afxnews.com

Related Content