(RTTNews) - A top Federal Reserve official said Friday that he expects the economy to regain "positive momentum" at some point in 2009 and noted that the new techniques the central bank is using to stimulate the economy may have to be taken away before they lead to inflation.
Speaking to the Maryland Bankers Association Annual Economic Outlook Forum, Richmond Fed President Jeffrey Lacker said he did not believe there would be a problem with deflation, the kind of persistent decline in prices that took place in the Great Depression.
Rather, Lacker suggested that the amount of stimulus that authorities have put into the system could cause trouble down the road, by adding inflation pressures.
"Mixing monetary and fiscal policy is fraught with risks," the Richmond Fed president said, noting that there are many historical examples of trouble caused by central banks expanding their balance sheets.
To combat the recession and the turmoil in financial markets, the Federal Reserve has cut its benchmark interest rate effectively to zero. It has also implemented a number of lending facilities aimed at providing liquidity to the markets, with the Fed's monetary liabilities rising from $840 billion last September to about $1.7 trillion by the end of the year.
"Containing inflation may require closing down credit programs, or finding an alternative, non-monetary financing arrangement for them," Lacker said.
He added, "Price stability, after all, is the vital first ingredient in financial market stability."
Lacker said easy monetary policy and low interest rates will help the economy get back on track in 2009. This will be assisted by more moderate energy and commodity prices, which have come down substantially since the middle of last year.
The economy will also be helped by a stabilization of new home building, which dropped off sharply amid the housing slump of the past couple years.
Lacker was unenthusiastic about the near-term prospects for the housing market but said that the sharp slowdown that has taken place so far makes a further weakening unlikely.
"The housing market is by no means healthy right now; inventories of unsold, vacant homes are still large in many areas of the country, and, as a result, average home prices still are declining at a rapid pace," Lacker said.
He added, though, "Having said that, I find it hard to believe new home construction has too much farther to fall, and that would imply that residential investment will soon exert much less of a drag" on the economy.
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