Fed: Slower growth, higher unemployment, higher inflation
WASHINGTON -- The Federal Reserve on Wednesday issued a downbeat assessment of the economy, predicting growth this year will be far slower than forecast just last fall, while inflation and unemployment will be higher.
The forecast was released in conjunction with the minutes from the Fed's Jan 29-30 meeting, at which Fed policymakers said they were growing increasingly worried about the economy, and "several" officials noted there was a very real possibility of an actual downturn.
"Several participants noted that the risks of a downturn in the economy were significant," the minutes of the meeting held January 29-30 said.
The risk of both slower growth and higher-than-anticipated inflation — as underscored by a separate report Wednesday showing rising consumer prices — puts the Fed in a bind as it tries to keep the economy from listing. The Fed has made deep interest rates cuts in the past six months to try to spur growth.
Stephen Cecchetti, professor at the Brandeis International Business School, notes that not only are prices rising, but consumer expectations for higher inflation are moving up — a bad sign for the Fed. "My hope is that one of two things will happen: Either economic slack will bring inflation down, or the financial system will recover quickly," Cecchetti said in an advisory. "In the first instance, low interest rates will be warranted; in the second, rates the Fed will have to as flexibly on the way up as it has been on the way down."
Most Fed officials also saw a greater risk chance that their new projections were too optimistic — rather than too pessimistic — given deepening problems in housing and credit markets and rising energy and commodity prices.
"The possibility that house prices could decline more steeply ... was perceived as a significant" potential problem, the Fed forecast said, adding that most officials "viewed the risks to their forecasts as weighted to the downside."
Central bank officials were "especially" worried about a scenario under which "weaker economic activity could lead to a worsening of financial conditions and a reduced availability of credit, which in turn could dampen economic growth."
The central bank expects the economy to expand 1.3% to 2.0% in 2008, "appreciably below its trend rate." That's a sharp drop from the Fed's October projection for 2008 growth in a 1.8% to 2.5% range.
The forecast represents the consensus of Fed governors and regional bank presidents. It projects that unemployment in 2008 will range from 5.2% to 5.3%, up from its 4.8% to 4.9% October projection. Consumer inflation is expected to hit 2.1% to 2.4% in 2008, compared with the October forecast of 1.8 to 2.1%. Core inflation, which excludes food and energy prices, is now put at 2.0% to 2.2%, up from the earlier 1.7% to 1.9% range.
The forecast includes the positive impact of a "stimulus" package of business and personal tax cuts. Some Fed officials said the stimulus package should provide a boost during the second half of this year.
Fed officials, who have cut a key interest rate to 3% from 5.25% in September said the rate cuts would help stabilize the economy over the longer term, with growth accelerating to a 2.5% to 3.0% range by 2010 and unemployment moderating to 4.9% to 5.1%. But Fed officials had widely divergent views of how fast the economy would rebound. Further, core inflation in 2010 — pegged at 1.7% to 1.9%, was "judged likely still to be a bit above levels" that some Fed officials saw as appropriate.
There are signs that the Fed's outlook may be too optimistic in some areas. The Labor Department said Wednesday that consumer inflation rose at an unexpectedly rapid clip in January. The consumer price index gained 0.4% during the month. Overall, inflation has been running at a 6.8% annual rate in the past three months, with core inflation running at a 3.1% annual rate.
Much of the increase in the January consumer inflation numbers was due to rising food and health care costs. The lower dollar and rising prices elsewhere in the world may also be boosting the price of imported goods. The situation doesn't appear likely to improve any time soon. Energy prices have spiked in recent days, with crude oil prices Tuesday closing above $100 a barrel for the first time ever.
Fed Chairman Ben Bernanke in congressional testimony last week said he expected the nation to skirt a recession. But that could be a distinction without much of a difference.
In a Wednesday speech, St. Louis Fed President William Poole said the economy was "limping along."
"Some believe recession is at hand; others, and I include myself in this group, believe the economy will skirt recession. The difference in view may not be very large, as an economy growing at a barely positive rate will look and feel about the same as one with output falling slightly," he said.
Bernanke and his colleagues decided last year to release more frequent, quarterly forecasts as part of an overall push to increase openness and predictability at the central bank. But the policy change has come in the midst of credit and financial market turmoil which has made long-term forecasting more difficult than usual, and less useful in determining the short-term arc of Fed policy moves.
Twice in the past six months, the Fed has held emergency meetings to alter interest rate policy to keep up with rapidly changing conditions. The central bank cut the Fed funds rate, what banks charge each other for overnight loans, by 1.25% from Jan 22-30, the steepest rate cuts in its recent history. The rate is used by many lenders as benchmark for setting interest rates on consumer and business loans.
The minutes also showed continued concern about inflation, with some Fed officials arguing that Fed rate cuts may have to be taken back at a quick pace when the economy improves.