Q: Mr Chairman, we are very anxious to hear from you on the outlook for the monetary policy and the US economy.
A: The outlook is good. We see some inflation risks on the horizon. Rising energy prices would add to that risk. But, given an appropriate monetary policy, growth should be solid and sustainable at or slightly above potential, and inflation risks should moderate over time.
Certainly, one of the risks to the solid outlook for growth is the inflation risk. Inflation, if allowed to raise its head, might just persist and even affect growth adversely. We may have to raise rates more than we would otherwise have done. We, at the Fed, are aware of this risk.
Q: Mr Chairman, that is reassuring. If growth were solid and sustainable, it might mean that our economic growth would exceed our potential growth rate. You are well aware that we are growing for more than four years at a solid pace. The unemployment rate is below 5.0% and the capacity utilisation rate is above 82%. There is not much spare capacity left. So, how can the Fed keep growth solid and sustainable and expect inflation to come down?
A: You are raising interesting questions. In a world of globalisation, spare capacity is not defined by boundaries. All the world?s production capacity and labour capacity is available for the US.
Q: I agree with you. But, let us take India and China. Both have been growing at an impressive rate themselves and skill shortages are rising. Wage growth has been good, at least in India. In other words, in the short-term, their capacity to help us rein in our inflation might be somewhat more limited than a central banker could, or should, safely assume.
A: H…mm. That had a tough edge. I am not sure that they have exhausted their potential, even in the short-term, to help us keep our inflation contained. In any case, I agree their contribution to our inflation path and outlook needs to be more carefully examined before we could conclude whether they have been helpful or not. My crucial point is the rider, ?given appropriate monetary policy.? You had ignored that, I believe.
Q: No, Mr Chairman, I had not ignored it. In fact, I was hoping that you would re-emphasise it. I find your reiteration very reassuring. What you are saying is that you might raise rates by another 25 to 50 basis points, snuff out any inflation pressure and thus allow growth to continue at a rate consistent with potential. That is very reassuring.
A: No, I did not say that. We are aware that we have already raised 425 basis points and, further, we are aware that housing is slowing. We will act only if higher inflation in the next one to three months continues into higher inflation over the subsequent six months.
Q: Mr Chairman, I am now a bit confused and concerned. You said that if inflation is allowed to raise its head, it might persist and then affect growth adversely. How would you be sure that higher inflation in the next one to two months would not become higher inflation over the medium-term?
A: Well, we would look at various measures of inflation expectations of the public. If those measures of inflation expectations do not rise, then it is possible that higher inflation in the short-term would not become higher inflation in the medium-term.
Q: But, how does the public form its inflation expectation?
A: That?s easy. As long as the Fed enjoys credibility on fighting inflation, inflation expectations would remain stable.
Q: You have been on the job only for six months. Let us say the public sees the Fed sitting on its hands as inflation rises for the next one to three months. Let?s not forget that core inflation has gone up at an annual rate of 3.6% in the last three months. How do you think that doing nothing would add to your credibility? If it doesn?t, won?t inflation expectations rise? If they do, is there not a bigger risk that higher inflation in the short-term continues into the medium-term? Won?t that require the Fed to raise rates a lot more? Wouldn?t that leave a bigger mess, eventually?
A: I think I have been clearly misunderstood. I must call Maria to explain. (Calls out to Ms Maria Bartiromo at CNBC, ?Maria, Maria?).
The conversation ends.
?The writer is the head of research, Asia-Pacific and Middle East, Bank Julius Baer, Singapore. These are his personal views