WASHINGTON, Nov 28 (Reuters) - Federal Reserve Vice Chairman Donald Kohn on Wednesday signaled a deliberate shift in the tone of policy toward further interest rate cuts during a speech and debate before the Council on Foreign Relations.
The following is a selection of excerpts from his remarks during the question-and-
MARKET DEVELOPMENTS SINCE OCT. 31
"The one thing that has really changed since the last meeting is the deterioration in credit markets and financial markets.
"I never expected the markets to return to normal functioning very rapidly after the upsets of August and September. I thought this was a process that would take some time. Credit is going to have to rechannel out of the securities markets, back into the banks to a certain extent.
"Instruments are going to have to be restructured so that they are more transparent, and are better able to be understood. The housing market and the macro economy are going to have to stabilize so that uncertainty goes away before things can get better. And I expected some year-end pressures.
"But I have to admit that, speaking for myself ... the degree of deterioration that has happened over the last couple of weeks was not something that I personally anticipated.
"I think the losses that ... seem in train and have been announced were greater than people expected. This raised questions about financial institutions, how much capital they had, how vigorous they would be in pursuing new loans.
"Financial institutions became more cautious, and I think this process is one that we are going to have to take a look at when we meet in a couple of weeks."
GROWTH OUTLOOK MIXED - LABOR SOLID, SPENDING SOFTER
"We've got a lot of information since the last FOMC (Federal Open Market Committee) meeting (on Oct. 30-31), and we've got a lot of information to come in before the next FOMC meeting. I think the economic information that we've got about the path of the economy has been kind of mixed since the meeting.
If I think about labor markets, I think that we and many people in this room were surprised ... at the strength of the employment gain in October. And since then, initial claims for unemployment insurance have been higher, on a moving average basis, but they remain pretty low.
"I would say what we know is that ... employment has continued to expand. This provides an important pillar underpinning for the economy, because when employment is expanding, incomes are expanding and people can consume out of those incomes. That has been on the positive side in terms of incoming data.
"I think on the other side, the spending data have been maybe a little to the soft side ... I would say that there has been a noticeable slowing in the growth of consumption. From what we know now, the partial data that we have in hand doesn't suggest that consumption has stopped growing. It is still expanding, but at a slower pace.
"That is not entirely unexpected. I think when you've looked at the surveys of household attitudes, you saw people getting more concerned. When you thought about the declines in housing prices, and certainly the failure of housing prices to go up, and many of them to decline, folks are looking at their balance sheets and thinking that their wealth is eroding to some extent ... and they are going to be a little more cautious in spending. And I think that we are beginning to see that on the consumer side ... (but) we expected a little softness."
HOUSING NOT BOTTOMED
"I think the housing sector has continued to decline and erode at a very, very rapid rate, and while this was expected, I think it would be nice to see some early signs that it was beginning to stabilize and we haven't seen that yet.
"It would be nice to get a clue that sales were beginning to stabilize and builders were beginning to make some more progress in working down those inventories. As long as the inventories of unsold homes are there, and the new inventories of homes coming on to the market, particularly in the foreclosure process, looks high, that is going to put a lot of downward pressure on the housing market.
"I think we've seen weak housing data. We expected weak housing data, so it will be hard to assess. But I don't think that we've seen the bottom of that market yet."
INFLATION OUTLOOK - RISKS HAVE NOT EASED SINCE OCT. 31
"On the inflation side, I think the core data have come in at about a moderate pace. It is kind of stable. On the other hand, the dollar has dropped further, so import prices will under some upward pressure, and energy prices have gone up.
"So I don't think that the sources of risk that the committee saw on inflation at the last meeting -- (they) haven't gone away, and it is something that no central bank can afford to ignore. I think it is very important that we keep prices roughly stable, and people perceive that we are keeping prices stable. We cannot let inflation expectations start to rise. That would be a very bad dynamic."
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