NEW YORK, Aug 20 - The Federal Reserve can keep its monetary policy quite accommodative until the U.S. output gap narrows, Richmond Fed President Alfred Broaddus said in an interview with CNBC television on Wednesday. The output gap measures unused labor and capital capacity and is particularly wide right now, meaning the economy can potentially grow quickly without generating inflation. "Until actual growth in demand accelerates and allows this gap between the potential level of growth in the economy and the actual level to close, we're going to have a situation where I think the Fed can probably remain quite accommodative," said Broaddus. He added he was confident that growth would indeed accelerate in the months ahead.
"I'm a little more optimistic now. ... I don't want to overstate it -- we're still watching this very closely -- but at least as far as many of the key recent numbers are concerned things look a little stronger," he said. He noted the main headwind for the U.S. economy remained the labor market. "We have not seen the pickup in employment we really need to see to be confident this expansion really has lasting momentum," Broaddus said. Asked if there was some credibility problem between the Fed and the financial markets, Broaddus answered: "I've been reading about that, and maybe there is."
Many in the markets have faulted the Fed for leading them to believe the central bank was concerned enough about deflation to take radical policy measures such as buying longer-term Treasuries. That impression was one reason benchmark 10-year yields plunged to 45-year lows around 3.07 percent in June. But all that changed when the Fed only cut rates by a modest quarter percentage point in June and played down the dangers of deflation. Since then, yields have climbed all the way to 4.35 percent. "I recognize the point. ... We mentioned the possibility of unwelcome additional disinflation; the markets interpreted that one way," said Broaddus. "We're aware that in a situation where the inflation rate is as low as it is today ... there's the possibility of additional disinflation and we were simply trying to say that we recognize that; that we were prepared to deal with it," Broaddus explained.//