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CNBC EXCLUSIVE: CNBC TRANSCRIPT: CNBC'S STEVE LIESMAN SITS DOWN WITH JAMES BULLARD, ST. LOUIS FEDERAL RESERVE BANK PRESIDENT, TODAY ON CNBC'S "POWER LUNCH"

LIESMAN: GREETINGS FROM ST. LOUIS FOR AN EXCLUSIVE INTERVIEW WITH JAMES BULLARD. THE ST. LOUIS FED PRESIDENT, A COUPLE VITALS. HE JOINED THE FED IN 1990 AND HAS BEEN PRESIDENT FOR THE LAST YEAR OR MORE. HE WILL BECOME A VOTING MEMBER NEXT YEAR. THANK YOU FOR JOINING US.

BULLARD: PLEASE TO BE HERE.

LIESMAN: LET'S BEGIN IN THE BROADEST POSSIBLE WAY GIVE YOUR OUTLOOK ON THE ECONOMY. ARE WE HEADED ANY TIME SOON FOR A QUARTER OF POSITIVE GROWTH?

BULLARD: I THINK WE ARE. I'M CAUTIOUSLY OPTIMISTIC FOR THE SECOND HALF OF THIS YEAR AND HOPEFULLY WE CAN GET SOME GROWTH AND START OUR PATH TO RECOVERY.

LIESMAN: HOW DOES THIS QUARTER LOOK? WE DID A MINUS 6, A MINUS 6 AND NOW WHAT?ARE WE GOING TO DO A MINUS TWO AND THEN THE THIRD QUARTER IS THE ONE THAT IS POSITIVE?

BULLARD: I THINK THE THIRD QUARTER HOPEFULLY WILL TURN AROUND AND ONE OF THE THINGS ABOUT WHEN THE ECONOMY IS DOWN IS YOU ARE VULNERABLE TO FURTHER SHOCKS THAT YOU DON'T ANTICIPATE AT THIS POINT. BARRING THAT, I THINK WE WILL GET POSITIVE GROWTH IN THE SECOND HALF YEAR.

LIESMAN: GIVE US YOUR ASSESMENT ON THE BANKING SYSTEM NOW IN TWO WAYS ONE IS RELATIVE TO OCTOBER AND ONE IS RELATIVE TO NORMAL.

BULLARD: RELATIVE TO NORMAL, IT'S STILL STRESSED. I HAVE TAKEN ENCOURAGEMENT A LOT OF THESE MEASURES OF STRESS HAVE COME WAY OFF OF THEIR HIGHS. IF YOU LOOK AT LIBOR OIS SPREADS, THEY ARE REALLY HIGH IN SEPTEMBER AND OCTOBER AND HAVE BEEN HIGH EVER SINCE JULY OF 2007 AND THEY'RE GETTING MUCH MORE COMFORTABLE LEVELS BUT NOT REALLY PRE-CRISIS LEVELS. THERE IS A LOT OF SIGNS THAT FINANCIAL STRESS IS IS ABAITING HERE.

LIESMAN: ONE OF THE SIGNS SOME PEOPLE SAY ARE RISING INTEREST RATES.YOU HAVE THE 10-YEAR YIELD AND IT SETTLED DOWN AND STILL QUITE A BIT HIGHER THAN IT HAD BEEN.NOT ALL THAT LONG AGO. HOW DO YOU LOOK AT THE HIGHER RATES?A SIGN OF IMPROVING ECONOMIC OUTLOOK OR CONCERN ABOUT INFLATION?

BULLARD: A LITTLE OF BOTH. I THINK WE HAVE SOME EXPECTED INFLATION COMPONENT IN THERE AND ALSO SOME IMPROVEMENTS ABOUT THE REAL ECONOMY. YOU HAVE A MIX OF THE TWO.

LIESMAN: IS THERE ANYTHING ABOUT THE INCREASE OF RATES THAT SUGGEST TO YOU A NEED IN YOUR OPINION FOR THE FED TO CHANGE POLICY FROM PURCHASING TREASURIES OR PURCHASING MORTGAGE-BACKED SECURITIES?

BULLARD: I THINK THE RISK IN COMING OUT OF SEPTEMBER AND OCTOBER IS YOU MIGHT GET INTO THIS DEFLATIONARY PSYCHOLOGY AND YOU MIGHT HAVE A JAPANESE STYLE OUTCOME WHERE YOU HAVE A PERSISTENT DEFLATIONARY TRAP WITH ZERO NOMINAL INTEREST RATES TO ME THAT WAS A BIG RISK FOR THE U.S. AND THE WORLD. I THINK THAT IS ABAITING SOME ONCE WE GO THROUGH THE SPRING ONE OF THE THINGS I LIKE TO LOOK AT IS THE FIVE-YEAR TIPS BREAK EVEN INFLATION RATES.THERE IS A PROBLEM AND AS A ROUGH MEASURE, IT WAS DEEPLY NEGATIVE LATE LAST YEAR, EARLY THIS YEAR.IT'S COME UP ABOVE ZERO ABOUT 145 BASIS POINTS TODAY. THAT'S A MARKET EXPECTATION OF INFLATION OVER THE NEXT FIVE YEARS. 1.45%.THAT'S NOT A LOT OF INFLATION, BUT IT'S BETTER THAN THE DEFLATION THAT IT APPEARED TO BE EARLY THIS YEAR OR LATE LAST YEAR. I THINK WE ARE ROUNDING THE CORNER HERE AND AVOIDING THE DEFLATIONARY OUTBACK AND OVER THE MEDIUM TERM, THERE IS INFLATION RISK. IT'S SHOOTING THE RAPIDS HERE.YOU HAVE TO AVOID BOTH.

LIESMAN: RIGHT. WHICH MEANS WHEN YOU SHOOT THE RAPIDS, YOU HAVE TO MAKE QUICK TURNS. WHICH BRINGS US TO AN INTERESTING CONCEPT THE EXIT STRATEGY FOR THE FEDERAL RESERVE. HOW NEAR IS THAT ON THE HORIZON?

BULLARD: THE COMMITTEE IS GOING TO THINK VERY HARD ABOUT THIS THIS SUMMER.WE HAVE LOTS OF IDEAS ON THE TABLE ABOUT HOW TO APPROACH IT. I WOULDN'T WANT TO PREJUDGE HOW THAT'S COMING OUT, BUT WE THINK ABOUT HOW TO RUN IT. YOU KNOW WHAT I WOULD LIKE TO SEE AND MAYBE I AM THE ONLY ONE I WOULD LIKE TO SEE IS THIS TAYLOR RULE FOR ASSET PURCHASES. YOU KIND OF WANT TO KNOW AS THE DATA COMES IN.

LIESMAN: LET ME JUST EXPLAIN THIS THE TAYLOR RULE IS SOMETHING THAT FED POLICY MAKERS USE IF THEY WERE TO PUT INTEREST RATES. SINCE IT'S ZERO, THAT'S NO GOOD.IT HAS TO RULE FOR THE OTHER SIDE IN ASSET PURCHASES.

BULLARD: SOMETHING LIKE THAT SO AS THE DATA COMES IN ON THE ECONOMY THE SECOND HALF OF THE YEAR AND INTO 2010, IF IT COMES IN STRONGER THAN EXPECTED, MAYBE WE DO A LITTLE LESS OR IT COMES IN WEAKER THAN EXPECTED MAYBE WE DO A LITTLE MORE. THAT'S WHAT THE TAYLOR RULE IS GOOD AT. YOU LIKE TO HAVE THAT GUIDANCE FOR THE ASSET PURCHASES. WE ARE NOT THERE YET, BUT I WOULD LIKE TO GET THERE IN BROAD TERMS.

LIESMAN: LET'S TALK ABOUT ASSET PURCHASES.THE FED IS COMMITTED TO BUYING 300 BILLION DOLLAR IN TREASURIES AND 1.2 TRILLION IN MORTGAGE BACKED SECURITIES AND WE BOUGHT ABOUT A HALF TRILLION COMBINE OF THE TWO YET RATES ARE MUCH HIGHER. WHAT HAVE WE GOTTEN FOR OUR EXPENDITURES?

BULLARD: IF YOU LOOK AT THE ANNOUNCEMENTS WHEN WE ANNOUNCED THOSE OF COURSE MARKETS ARE FORWARD LOOKING.IT'S PRETTY SUBSTANTIAL.SO I DO THINK WE HAD SOME IMPACTS. THERE IS A LOT THAT GOES ON AND A LOT OF THINGS THAT COME IN ON THE ECONOMY.BASED ON THE ANNOUNCEMENTS I THINK THAT IT WASN'T LIKE IT WAS ZERO IMPACT.

LIESMAN: BUT SINCE THEN AND THE CONTINUATION --

BULLARD: I DO THINK HOWEVER THAT GENERATING ANNOUNCEMENT EFFECT IS NOT NECESSARILY A SIGN OF GREAT POLICY.WHAT YOU ARE REALLY DOING IS SURPRISING THE MARKET. IN A PERFECT WORLD AND OBVIOUSLYWE HAVE BEEN REACTING TO A LOT OF DIFFICULT PROBLEMS HERE, BUT IN A PERFECT WORLD MARKETS WOULD ANTICIPATE WHAT YOU ARE DOING AND IT FITS INTO INTEREST RATES AND FEED INTO HOW THE ECONOMY ISREACTING.

LIESMAN: IF YOU HAD IT TO DO-OVER AGAIN, DO YOU THINK IN THIS ENVIRONMENT YOU WOULD BE BUYING TREASURIES.

BULLARD: I THINK ONE THING ABOUT TREASURY PURCHASES IS THAT THE FED ALWAYS BUYS TREASURIES. EVEN BEFORE THE CRISIS BEGAN YOU HAVE A THIRD OF THE SHORT-TERM AND A THIRD IN THE MIDDLE AND THIRD IN THE LONG-TERM. SO IT'S NOT A RADICAL POLICY.IT SHIFTED SOME TO THE LONG END, BUT YOU CAN SHIFT IT BACK. I DON'T SEE IT AS RADICAL AS SOME PEOPLE DO.

LIESMAN: THE TREASURY THIS MORNING TALKING ABOUT ITS REGULATORY REFORM OR PROPOSALS.IT PUTS THE FED AT THE CENTER AS A SYSTEMIC RISK REGULATOR.ARE YOU COMFORTABLE FOR THE FEDERAL RESERVE AND DOES IT DISTRACT FROM THE MAKING OF MONETARY POLICY?

BULLARD: THE FED WAS FOUNDED AS THE STABILITY REGULATOR FOR THE ECONOMY.THAT WAS THE ORIGINAL INTENTION COMING OUT OF THE PANIC OF 1907. IF YOU HANG AROUND, YOU KNOW THERE IS TOP REGULATORS THAT ARE TALKING ABOUT SYSTEMIC RISKS THAT MIGHT BE AFFECTING THE ECONOMY AND TALKING ABOUT THE TECH BUBBLE AND MY PREDECESSOR AND TALKING ABOUT THE RISKS OF THE GSE. YOU HAVE GARY STERN UP IN MINNEAPOLIS TALKING ABOUT TOO BIG TO FAIL. NED GRAMLIN TALKING ABOUT SUBPRIME. THE FED NATURALLY HAS PLAYED THIS SYSTEMIC RISK ROLE, BUT WITHOUT ANY POWERS OTHER THAN TO KEEP TRACK OF AND TO WARN ABOUT SYSTEMIC RISK.WITHOUT ANY SPECIAL POWERS TO ADDRESS THEM. THE KEY ISSUE IN RISK REGULATION IS WHAT POWERS DO YOU WANT TO GIVE THE SYSTEMIC RISK REGULATORS WHETHER IT'S THE FED OR ANYTHING ELSE.WHAT IS IT YOU WANT THEM TO DO WHEN THEY HAVE SPOTTED A NEW SYSTEMIC RISK? THE DEBATE HAS TO SHARPEN AND TALK ABOUT THE ISSUES.

LIESMAN: THERE WILL BE TIME FOR THAT DEBATE AND I THANK YOU VERY MUCFOR YOUR COMMENTS AND THOUGHTS.I LOOK FORWARD TO THE RETURN TO ST. LOUIS.





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