Richmond Federal Reserve Bank President Jeffrey Lacker said that slowing economic growth and weakening labour markets in the U.S. may prompt banks to further reduce their lending to consumer and firms, thus leading to further credit tightening.

"The deterioration of economic conditions is playing a more prominent role in the tightening of credit terms right now than the direct effects of financial market turbulence," Lacker said in a speech given in Jerusalem on Monday.

Lacker also said that it was "reasonable" to expect the U.S. economy to begin its recovery by 2009. However, the policy-maker added that it was still necessary to keep inflation expectations under control.

"As a recovery begins, the path of least resistance is often to hold the policy rate at a low level until it is completely clear that recuperation is complete," he said. "It is crucial that we not allow expectations of future inflation to ratchet higher during this recession."

On Oct. 29, the Federal Reserve decided to cut its interest rate by 50 basis points to 1%. The move marks the second time in one month that the Fed had decided to cut rates, Earlier in the month, in a co-ordinated move with the European Central Bank, the Bank of England, the Bank of Canada, the Swiss National Bank and Sweden's Riksbank, the Fed reduced its interest rate by half a percentage point to help counteract the effects of the intensifying financial crisis on the economy.

In his speech, Lacker said that the Fed's monetary policy may have been too loose for too long in 2003 and 2004 and could have provided "some positive inducement" for mortgage lenders to take risks.

By Todd Wailoo and edited by Nancy Girgis
©CEP News Ltd. 2008