MNI INTERVIEW: Next Recession Likely "Mild": Ex-Fed's Lacker

By Jean Yung

     WASHINGTON (MNI) - U.S. expansion looks set to continue and the next

recession will likely be mild, former Richmond Fed President Jeff Lacker told

MNI in an interview, calling for the Federal Reserve to take interest rates

above 3% and slash the size of its balance sheet.

     "The Fed should get above 3% and not be shy about going a little further to

make sure inflation remains under control," said Lacker, who was regarded as a

hawk when he left the Fed in 2017 and is now a professor at Virginia

Commonwealth University.

     Tax cuts and higher government outlays have provided impetus for defense

spending and business investment, and while that's expected to slow as fiscal

stimulus wanes next year, it could well continue.

     The housing sector also appears to be cooling, but at a moderate rate that

the "economy is capable of absorbing over time," and there is little evidence

that commercial office space is overbuilt, Lacker said.

     "My guess is that the next recession will be mild and slow -- more like the

two before the last one," he said. "I don't see large magnitude risks out there

on the financial side at this point."

     --BALANCE SHEET

     Lacker also called for the U.S. central bank to quickly liquidate the

trillions of dollars of assets on its bloated balance sheet and return it to the

much leaner size it was prior to the financial crisis.

     Maintaining a large balance sheet makes the Fed vulnerable to political

interference, Lacker said, while the extra hundreds of billions of excess bank

reserves currently in the system are not needed to effectively implement

monetary policy.

     "I think we should reduce the size of the balance sheet to the minimum

necessary to operate a floor system," he said, referring to the Fed's

post-crisis framework for controlling interest rates. The Fed currently sets the

interest paid on bank reserves rate close to its target fed funds rate, and IOER

acts as a floor for interbank lending rates.

     "I think it only takes $10 billion to $20 billion in excess reserves to

push the rate down to the floor quite accurately," Lacker said.

     --MINIMAL RESERVES

     The passive roll-off of Fed assets currently underway is "going too

slowly," Lacker said, arguing that markets could absorb active sales of assets

at a scale of roughly $100 billion a month -- "if you telegraph it in advance."

     Having shrunk from $4.5 trillion to $4.1 trillion over the past year or so,

the balance sheet remains some four times larger than its pre-crisis peak of

just under $1 trillion. Of that $4 trillion, the $1.8 trillion arsenal of

Treasuries and agency mortgage-backed securities opens the central bank to

political pressures to channel the money toward certain industries or to fund

government initiatives as have happened in the past, Lacker said.

     "I think there's a host of capabilities that the Fed doesn't need and that

open them up to Congressional pressure," he said, repeating his longstanding

position that holding agency MBS invites Congressional interference.

     The Fed fears having to realize losses on its portfolio if it actively sold

off securities prior to maturity, Lacker said, but "it wouldn't take much more

for losses to be larger, and it makes a central bank politically vulnerable to

have a negative net worth."

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

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