Fed's Mester: Further Gradual Rate Increases Warranted

--Favor Phasing Out Bal Sheet Reinvestments in 'Near Future'

--Post-Harvey Rebuilding to Spur Growth After Likely Dip This Quarter

--Inflation Will Return to 2% Target Over Next Year

     PITTSBURGH (MNI) - Federal Reserve Bank of Cleveland President Loretta

Mester on Thursday again called for further gradual increases in the Fed's

benchmark interest rate and starting to wind down the Fed's balance sheet in the

"near future," saying doing so would help sustain the economic expansion. 

     Though inflation will continue to be held down by temporary factors for

slightly longer, Mester said conditions remain in place for inflation to

gradually return to the Fed's symmetric 2% objective over the next year. In

addition, the Fed has achieved its maximum employment mandate, she said. 

     Mester does not vote on the FOMC this year. Below are key excerpts of her

speech: 

     On rates: "In my view, if economic conditions evolve as anticipated, I

believe further removal of accommodation via gradual increases in the fed funds

rate will be needed and will help sustain the expansion. A gradual removal of

accommodation helps avoid a build-up of risks to macroeconomic stability that

could arise if the economy is allowed to overheat, as well as risks to financial

stability if interest rates remain too low, encouraging investors to take on

excessively risky investments in a search for yield or engendering other

financial imbalances." 

     On balance sheet: "The FOMC's intention is to reduce the size of the

balance sheet over time to the smallest size needed to implement monetary policy

efficiently and effectively and, in the longer run, to hold primarily Treasury

securities. ... The FOMC expects to begin implementing the program relatively

soon, and I favor doing this in the near future. ... In my view, other factors,

including the ongoing discussions about the debt ceiling, rising geopolitical

tensions, and political uncertainty, would be more likely to influence Treasury

yields in the near term." 

     On Hurricane Harvey: "The hurricane in the Gulf will likely dampen economic

activity in the current quarter, with subsequent rebuilding efforts adding to

growth in subsequent quarters. ... We are gathering information from our

contacts, but it is still too early to assess the full economic impact of the

storm. Experience suggests that soon after the storm passes, clean-up and

rebuilding begin, oil refineries are assessed and brought back on-line, and

shipping channels reopen." 

     On inflation: "My current assessment is that inflation will remain below

our goal for somewhat longer but that the conditions remain in place for

inflation to gradually return over the next year or so to our symmetric goal of

2 percent on a sustained basis. These conditions include growth that's expected

to be at or slightly above trend, continued strength in the labor market, and

reasonably stable inflation expectations.

     "Some of the weakness in recent inflation reports reflects special factors,

like the drop in the prices of prescription drugs and cell phone service plans

earlier in the year. It may take a couple more months for these factors to work

themselves through, but these types of price declines aren't signaling a general

downward trend in consumer prices from weak demand. Instead, they reflect

supply-side factors and relative price changes. At the same time, we need to

recognize that weak inflation numbers, no matter what the source, can become a

problem if they start to undermine the public's expectations about future

inflation. If inflation expectations were to become unanchored and began

steadily declining, it would be much more difficult to raise inflation back to

the Fed's goal." 

     On employment: "My assessment is that from the standpoint of the cyclical

conditions that monetary policy can address, we have achieved the maximum

employment part of the Fed's monetary policy mandate. ... Although we may see a

weaker payroll employment number for September due to the hurricane, I expect

that labor market conditions will remain healthy and that over the next year the

unemployment rate will stay below 4-3/4 percent, my current estimate of its

longer-run rate." 

     On wages: "For me, a more salient factor in the relatively slow growth in

wages is the low level of productivity growth. ... Unless productivity growth

picks up, I wouldn't expect to see a strong acceleration in wages."

     On economic growth: "Over the expansion, output growth has maintained a

moderate pace of a bit more than 2 percent, on average, and I anticipate that

GDP will expand over the next year or so at a pace somewhat above trend, which I

estimate at 2 percent." 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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