At the Fed, a Debate Over Countering Inflation Grows Louder

With the decline in oil prices, inflationary pressures are easing for the moment. The Federal Reserve’s policy makers all acknowledge as much. But that has not halted their debate over whether to raise interest rates now to avoid higher inflation in the future.

The issue moved to a broader forum over the weekend: the Fed’s annual gathering in this mountain resort. The event drew central bankers and economists from abroad, the latter sometimes quite critical of what America’s central bank has done.

“The Fed overreacted to the slowdown in economic activity,” Willem H. Buiter, a professor of European political economy at the London School of Economics and Political Science, declared in his presentation, offering harsh criticism of his hosts. The Fed, he added, “cut the official policy rate too fast and too far and risked its reputation for being serious about inflation.”

Ben S. Bernanke, the chairman of the Federal Reserve, rejects that thinking, as do a majority of the Fed’s policy makers. They argue — and several of them repeated their arguments in interviews here that were mostly off the record — that they had no choice but to cut the key lending rate that the Fed controls to 2 percent from 5.25 percent in just eight months. Otherwise, they said, the housing and credit crises would have resulted in much more damage to the economy.

Now, they argue, the so-called federal funds rate must be kept at 2 percent — for no one knows how long — so that banks and other lenders can borrow at low rates and lend at higher ones, using their fattened earnings from this process to rebuild the capital they need. The banks’ capital eroded as numerous loans made during the bubble years went bad and were written off, reducing their ability and willingness to lend to the public.

“Lenders have been hit by a shock so severe that they are contracting and withdrawing from private sector lending,” Janet L. Yellen, president of the Federal Reserve Bank of San Francisco, said in an interview.

The view expressed by Professor Buiter, however — that a central bank’s overriding concern should be fighting inflation, while a sinking economy is left to be refloated by other means — is welcome thinking for the five or so Fed policy makers, all of them presidents of regional Fed banks, who say that the Fed must begin to raise rates right away.

Mr. Bernanke, in a speech here, said that inflation is likely to moderate as commodity prices come down and the dollar stabilizes. But the Fed bank presidents who want a rate increase now say that he is missing the point. Unless the Fed takes action, they say, people will lose faith in it as a guardian against a rising inflation rate.

When prices do begin to rise, according to their argument, instead of counting on the Fed to stop the process, the American public will ask for and somehow get higher wages to afford the rising prices. Employers will respond by pushing up prices even more — unless the Fed snuffs out this inflationary spiral, or any chance of it, by raising rates, starting now.

“These hawks at the Fed are arguing in effect that we have to throw people out of work more quickly than we already are to ensure against inflation,” said Jan Hatzius, chief domestic economist at Goldman Sachs.

So far, only one of the policy makers is pushing for higher rates. Richard W. Fisher, president of the Federal Reserve Bank of Dallas, has voted for a rate increase at recent Fed policy-making meetings, casting the lone dissenting vote among the Fed’s 11 voting governors and regional bank presidents. The other dissenters have voted with the majority to keep the key federal funds rate at 2 percent, actions that have muted their criticism of this approach.

Now, however, Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, is likely to join Mr. Fisher. Twice in the past, Mr. Plosser had cast a dissenting vote along with Mr. Fisher, the last time at the April 30 meeting, when the policy makers completed their rate cuts, bringing the federal funds rate to 2 percent. Ever since, he has voted with the majority and in doing so, he has maintained a silence that he says he intends to end soon.

“If we don’t reverse our accommodative stance sooner rather than later,” Mr. Plosser said in an interview here, “we will face rising inflation, which may be costly to deal with, and we will face a risk to the Fed’s credibility to contain inflation.”

CONTINUED : Too accommodative?

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