US to See Slow Recovery; Inflation a Threat: Hoenig

The U.S. recession is almost over but the recovery will be very slow, a top Federal Reserve policy-maker said Tuesday, while warning that even in this climate inflation is a long-term threat that should not be ignored.

AP

"I judge the economy at or near the bottom of the cycle," Thomas Hoenig, president of the Kansas City Federal Reserve Bank, told Reuters in an interview.

"I am not suggesting a V-shaped cycle," he said, referring to a quick bounce back. "I think...it will be a very slow recovery, given the seriousness of the problems in the financial industry and the slowness with which the capital in those institutions will be rebuilt," he said.

Hoenig, one of the U.S. central bank policy-makers who tends to be more hawkish on inflation, said U.S. economic growth would probably remain beneath its so-called long-term potential next year, and only return to this healthy level in 2011.

But even with plenty of slack in the economy, he said inflation must not be ignored or it could become a problem in four or five years' time.

"There are two things we can do wrong. One is pull it out too soon, the other is pull it out too late," he said, referring to the Fed's policy measures designed to stimulate the economy. Hoenig will have a voting seat on the Fed's policy panel next year.

The Fed has cut overnight interest rates to near zero and pumped a trillion dollars into credit markets to prevent them freezing since the failure last September of investment bank Lehman Brothers sparked a global financial crisis and severe U.S. recession.

• The Fall of Lehman Brothers: Click Here for the Special Report

Exit Strategy

Hoenig said the Fed's massive monetary stimulus must be gently withdrawn as the economy improves. "There are ways to pull it out when you see the economy showing signs of stability, pulling out the liquidity slowly, carefully," he said.

It is important to raise interest rates from current levels to a range around their neutral setting—the level where they neither stimulate nor restrict economic activity—before the ground is laid for future inflation, he said.

"We know we cannot have this highly accommodative policy without risking some pretty difficult inflationary consequences. So let's deal with that,” he said.

"Once we get the policy rate in a range...around neutral—I cannot identify what neutral is, but I know that it is not a quarter of a percentage point over a long period of time—you stay within that range," he said. Hoenig said that would be a more stable operating climate for the economy as it recovers.

"What we need to do is get to some level of policy that is more constrained, around a neutral level, and then let the economy work its way through,” he said.

Too Much Reform?

Hoenig said he welcomed an Obama administration proposal that would give the U.S. central bank oversight authority over large, interconnected firms whose collapse could damage the entire financial system.

But he expressed concerns about some other aspects of the administration's plans to revamp the regulatory system, including a proposal to create a new agency to oversee consumer financial products.

• Click Here for CNBC's Coverage of the Financial Crisis: Boom, Bust and Blame

"I have nothing but a high priority on consumer protection," he said, but called the proposed legislation "more a reorganization than an enhancement of consumer protection."

"You are going to increase the regulatory oversight...instead of simplifying it. And I think that raises the cost to the industry and that has to be paid for somewhere. I assume that it will be paid for by the consumer to some degree."

He also said a proposal to establish authority to wind down systemically important firms at risk of failing did not sufficiently define how the process would operate.

"I think that needs a lot of work. To me, its unintended consequence is to institutionalize 'too big too fail'," he said.

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