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Jennifer Dauble



Following is the unofficial transcript of a CNBC interview with Richmond Federal Reserve Bank President Jeffrey Lacker today on CNBC’s “Squawk Box.” All references must be sourced to CNBC.

Fed's Lacker Economic Forecast

Fed's Lacker: Fed's White Paper on Housing is Not Policy

STEVE LIESMAN: I am here with Richmond Federal Reserve president Jeffrey Lacker.

JEFFREY LACKER: Good to see you, Steve.

STEVE LIESMAN: Thanks for being here.

JEFFREY LACKER: Thanks for coming down to Richmond.

STEVE LIESMAN: Oh, it's great. Yeah. So let's talk about the economy-- in 2012. First of all, it looks like we're going to do-- what did you say? 1 3/4 in 2011?

JEFFREY LACKER: Yeah, that's where it's-- likely to come in. So 1 1/2, 1 3/4. I was forecasting three, 3 1/2 in the beginning of last year, so whatever I say about 2012 you should take with a grain of salt, obviously.

STEVE LIESMAN: Where'd you get it wrong then?

JEFFREY LACKER: So I think there were some temporary impediments in the beginning of the year, but I think the big thing is-- that some of the more persistent headwinds the economy are facing are more serious than we thought. Things like labor market mismatch. Things like the pall cast over-- investment decisions by-- sort of a range of policy issues that keep people a little uncertain. A little hesitant about investing. Making outlays. And then the housing-- market being flat on its back is another thing.

STEVE LIESMAN: So you're not doubling down on three in 2012?

JEFFREY LACKER: No, I think-- two, 2 1/2 is what I've put out there. Seems like a good guess to me. It's in line with a lot of other forecasters.

STEVE LIESMAN: And first of all, were you surprised, have you been surprised, by the drop in the unemployment rate in the last couple months. Are you a believer in that drop? And what's your forecast for 2012?

JEFFREY LACKER: I think we make more progress on unemployment-- but it's likely to be slow. Hard to get a beat on it because the labor force participation is hard to forecast. We-- about a decade ago it's-- like a secular trend shifted and we're seeing a decline in participation that's in part secular and in part cyclical and teasing out those two is really hard right now.

STEVE LIESMAN: So I think it's important for people to understand. When you talk about permanent factors or persistent factors, my guess is that you're thinking these are things that are not necessarily going to benefit from additional Fed policy.

JEFFREY LACKER: Oh, absolutely. The Fed doesn't control growth. We can interfere with it. We can impede it. But in general the growth rate the economy can crank out is determined by technology, people's preferences, resource endowments, other policies and the like. Our job is to keep inflation load stable.

STEVE LIESMAN: So all the king's quantitative easing and all the king's men couldn't really-- bring the unemployment rate down you don't think?

JEFFREY LACKER: I doubt it. Not on a sustained basis. I mean we've known this for decades. That monetary policy has an effect on real growth. It's transitory. And-- it definitely has an effect on inflation. So the extent that's-- we get some ease, to be able to get some traction, it's going to show up as inflation. Maybe as an increase in growth but only temporarily.

STEVE LIESMAN: What's your take on-- well, how do you go back and look at 2011 inflation? Is the PCE your best number and what is that number?

JEFFREY LACKER: PCE is, what, 1.7%-- on a 12 month basis in November.


JEFFREY LACKER: So-- really-- you know, edging up towards 2%. I think the trend now is around 2% if you look at core and some other things. We've had some low numbers-- with the fall in energy prices over the-- over the fall but-- I think we're headed towards-- inflation of about 2% the coming year.

I look back to 2003, 2004. We're coming out of that recovery. There was-- a late kind of ratchet up of core inflation that took a lot of forecasters by surprise. And I think the issue there was people were expecting-- under the sort of Phillips curve theory that-- that the-- a huge amount of slack would--

STEVE LIESMAN: It's a--explaining that. The Phillips curve being the tradeoff between employment and inflation?

JEFFREY LACKER: Right. People were expecting slack to have a big dampening effect on inflation in '04 and-- turned out-- not to be the case. And we got sustained inflation. About 2.9%, 3.0% over the four years from '04 through ‘07

STEVE LIESMAN: So you're not particularly worried, given-- even though the Fed's balance sheet is big and it's been growing a little bit and it's going grow with these Central Bank swap outs. You're not particularly concerned about inflation going-- past your target rate?

JEFFREY LACKER: Not this year. I think we're in good shape. Expectations seem to be well anchored. There're some risks to that outlook, naturally. I think-- you know, a sizeable commodity price shock that looks to be pretty persistent-- could throw that off. Could pass through the core if we don't respond appropriately.

STEVE LIESMAN: The Fed announced in it’s-- in the minutes of its last meeting that it's going to be publishing the future interest rate paths of the-- members and also the date of the first-- increase in the-- Fed funds rate. You want to share what your input's going to be?

JEFFREY LACKER: till then I've got some staff analysis to do. Some work with my-- people-- to do over the next couple of-- weeks before the meeting and we have to submit those projections. The thing to remember is it's just a natural extension of the projections that we've been releasing.

Since everyone's asked to submit their projections under what they do as appropriate policy. Now the-- these vary across the committee, as you might expect. So you'll get a picture of the divergence of views of-- committee members and participants about what appropriate policy path looks like going forward.

More broadly, you know, the thing to remember is that it's-- a forecast, not a commitment. That-- we all view policy naturally as contingent on the data, so if data come in differently than we expect those forecast paths will change. And-- not necessarily get the outcome you're-- that's written down there.

STEVE LIESMAN: The statement says right now that you're going to remain low through-- or you expect to remain low given the data through mid-2013.


STEVE LIESMAN: Is that date going to change, would you say?

JEFFREY LACKER: Well-- you know, I think when we wrote that down-- in August I think that the-- you-- widespread understanding is that it wasn't a commitment. That it was-- contingent on the data. And it's-- could change as the data came in. I think-- there's been discussion and debate about whether there's a way to improve on the way we provide forward guidance. One, some methods that maybe provide a little more-- sense to markets of that contingency.

STEVE LIESMAN: Let's talk about risks to your forecast. How serious a challenge is Europe right now?

JEFFREY LACKER: Reasonably serious, but I think we can handle it pretty well. I don't than it's going to push us into recession. A mild recession over there is going to cut into export growth. I think that's going to make the first half a little softer than the second half coming up. But it looks like we can weather it.

STEVE LIESMAN: So your forecast right now includes-- expects a mild--


STEVE LIESMAN: --recession in Europe?


STEVE LIESMAN: So if you avoid that, you'd obviously come up a little--


STEVE LIESMAN: --bit. And then if it's a little worse than--

JEFFREY LACKER: That's right.

STEVE LIESMAN: you have to bring down U.S.

JEFFREY LACKER: I think there's also some upside on the consumer.


JEFFREY LACKER: In the U.S. Yeah. You know-- confidence v gradually firming. Situation-- their finance balance sheet gradually firming. I think the consumer credit number for November was particularly striking. Those trends get sustained-- rather than-- essentially appearing as sort of a temporary-- blip-- I think, you know, we could get a stronger consumer next year than we expect. But that's just an upside risk to the forecast at this point.

STEVE LIESMAN: An upside risk we will take, right? You've agreed to hang out.


STEVE LIESMAN: We'll go to a commercial break and then we're going to do some more stuff where-- I think my-- colleagues in Englewood Cliffs are going to ask you some questions.

Steve Liesman: Hey thanks, Joe. I'm going to do one more with-- President Lacker and then we'll toss is back up to New Jersey. I want to ask you about the white paper that the Federal Reserve just put out on housing. It talked about land banks and rent to own programs. The Wall Street Journal wrote a very critical editorial basically suggesting that it wasn't the Fed's role to do that. It was making a step into fiscal policy. What's your opinion?

JEFFREY LACKER: We've got a lot of really good economists in the system. A lot of economists at the board of governors. They write as a-- matter of course in their research about a range of issues. They've studied the housing market very seriously. There's a lot of good information about the housing market in there.

There's some policy proposals in there-- that I'm not so sure about. It-- as a working paper it would have been a great contribution. Our people write working papers all the time and advanced policy proposals. They aren't the official view of the Federal Reserve Bank of the Richmond. But-- I think that would have been a good way to float those ideas.

STEVE LIESMAN: So you think it was inappropriate to float it as a white paper from the Fed rather than an economic research paper?

JEFFREY LACKER: Well, I've said before that I think we have to be really careful because of our special independence. That serves-- a really important purpose-- with regard to the conduct of monetary policy. And when the central bank strays into fiscal policy-- it gets itself entangled in politics-- and that can threaten our independence. And I think we've seen that in the last five years with a lot of the controversy that's been generated.

STEVE LIESMAN: I'm guessing Joe Kernen has a question. Joe?

JOE KERNEN: Did you talk about this nice profit from the Fed it was what about 80 billion dollars that went to the treasury based on what some people are saying is a more too aggressive strategy too much risk on the balance sheet I don’t know to me if you guys go up to 30 to 1 or so if you could turn that into a trillion dollars we could do some damage on the deficit here President Lacker what do you think?

JEFFREY LACKER: Well, we're not a hedge fund and we don't pretend to be one.

JOE KERNEN: Really Santelli says that all the time.

JEFFREY LACKER: Yeah, I know. So that's an aspect of our independence. That we have our-- these earnings, but they flow back to Congress. And that makes it important for us to be faithful stewards of the public's resources.

This is why when we take on credit risk-- we're really taking it on behalf of taxpayers. When we make a loan and-- sterilize that by selling U.S. treasury securities to make room in our portfolio, we're doing fiscal policy.

We're essentially selling treasury securities and investing the proceeds. And that's why it's-- a dangerous aspect of our policy and something that's beyond what we need to do to control inflation, which is control our liabilities.

JOE KERNEN: So the criticism is warranted then that this is not the business that you should be in and there is too much risk to the balance sheet. What if it had gone the other way you would be hearing about it right and as far as you know you don’t have a 2 and 20 pay structure do you. Ben doesn’t get 20% of the 80 billion wow that would be..

JEFFREY LACKER: Not that I've noticed.

JOE KERNEN: No but is that criticism warranted?

JEFFREY LACKER: Well, I mean I've been public-- my predecessors here, they're over the wall-- over our shoulder here on the wall here. Talk-- we started talking about this back in 1994. That-- Central Bank really needs to stick to-- monetary policy and that it's running risks if it gets involved in fiscal policy. Risks of-- political entanglements that could weaken our monetary policy independence.

SENATOR JUDD GREGG: That’s for sure and that’s the risk that the Fed is running right now but it had to run that risk I think because basically it was the only show in town for so long and the ability to keep the economy going and keep liquidity in the economy and so you dramatically expand your balance sheet but the sooner you can get your balance sheet back to what is historically been its size and the normal activity the better because that will give congress less excuse to be intrusive in the Fed’s activities and have an excuse for taking over monetary activity

JEFFREY LACKER: So liquidity that we provide in the economy and-- via our liabilities. And we can expand our balance sheet to no end by buying treasury securities. And we could have in 2008. Instead, we elected to take on private sector liabilities.

STEVE LIESMAN: Are you worried, President Lacker, about the Fed's independence through this election cycle here?

JEFFREY LACKER: I haven't seen-- as much threat to our independence-- in my career here-- as we've been seeing the last couple of years. There were some forays under Dodd-Frank. There were some bills introduced in Congress last year. Yeah, I'm a little nervous about how the Fed's going to be treated in this electoral cycle.

STEVE LIESMAN: What specifically—

BECKY QUICK: Did it make you more nervous President Lacker to see Ron Paul come in second in NH yesterday?

JEFFREY LACKER: I think cooler heads will prevail before we get a bill to abolish the Fed. So I'm pretty confident we'll-- we-- that in the end we'll-- people see the advantages of the institutional structure we have and see the value we add in keeping inflation low and stable.

STEVE LIESMAN: President Lacker, one-- you're in a unique position here. Two huge banks in your territory. A lot of regional banks as well. Part of your supervisory-- responsibilities. We had a discussion on Squawk Box a couple weeks ago. We were wondering how much progress have the banks made in getting the toxic assets off of their books? Are they are the bank balances in better condition now than they were?

JEFFREY LACKER: They definitely are. We've made tremendous strides over the last few years. And it's-- a story that doesn't go reported I think as much as it should be.

STEVE LIESMAN: And that's what we're doing right now.

JEFFREY LACKER: Excellent. Well-- so recognizing losses, that's-- a very rigorous process. It involves our-- supervisory staff that you'll talk to a little later today. In addition, I think the more important thing is what we've done to-- improve their liquidity management. They're far less dependent on short-term-- money market-- flows than they used to be. Short-term credit. They're far more able to withstand-- liquidity shocks than in the past. And-- that gives me some heart that-- that we're on the right course.

STEVE LIESMAN: And how vulnerable are they to Europe? For example, if there was a major meltdown there are they less connected to Europe than they were?

JEFFREY LACKER: I think they're less connected than they were. Less exposed-- than they were. I think the major vulnerability of our financial system to Europe has to do with the involvement in the money market funds. That we haven't fixed the structural problems there. And until we do-- they're vulnerable to flights.

STEVE LIESMAN: I need to steal one more minute. Charlie Evans at the Chicago Fed has a proposal to target unemployment or the amount of employment in the economy-- as part of the dual mandate. Perhaps an inflation target and an employment target. What's your opinion on that?

JEFFREY LACKER: We've been talking about Charlie's idea. His idea is that you-- it-- provide forward guidance by instead of picking a date on the calendar-- picking-- a number for unemployment and a number of inflation and say, "As long as unemployment's is above this and inflation's below this. We're going to keep policy easy."

I have real questions about that. I don't think the first number the Fed should publicly announce as an official committee about inflation should be this trigger rather than-- our numerical objective, which we still haven't taken the step of doing

STEVE LIESMAN: President Lacker. Thanks for joining us.

JEFFREY LACKER: Oh, my pleasure, Steve.

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