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Fed cuts US growth view, mulls inflation target

Fed cuts US growth view, mulls inflation target
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First Published: Thu, Feb 19 2009. 11 47 AM IST
Updated: Thu, Feb 19 2009. 11 47 AM IST
Washington: US Federal Reserve policymakers largely gave up hope for economic growth in 2009 and discussed setting an inflation target last month as a deepening recession heightened fears of a dangerous decline in prices.
With employment falling, the housing market showing no sign of stabilization, and credit conditions still tight despite official interest rates being cut to close to zero, the central bank projected the economy would shrink by between 0.5% and 1.3% this year, the Fed said in minutes of its 27-28 January policy meeting released on Wednesday.
In its previous quarterly forecast in October, the Fed offered a range for 2009 US gross domestic product that ranged from a decline of 0.2% to growth of 1.1%.
The central bank’s forecasts strip out the highest and lowest views to provide what it calls a “central tendency.” The latest forecast shows that two of 16 Fed officials still saw the possibility of at least some growth in 2009.
US stock markets showed little reaction to the revised forecast. Some economists noted that the gloomier economic view was still not as grim as many private forecasts.
The unraveling economy has pushed inflation uncomfortably low in the eyes of Fed officials, but the central bank stopped short of setting an explicit inflation target. An inflation target is seen by some policy-makers as an important took in achieving stable prices.
Instead, for the first time, the Fed issued long-range projections that offered a signal on how it expects the economy to perform beyond its normal three-year forecast horizon.
The projections in the minutes of the central bank’s policy-setting Federal Open Market Committee showed officials thought inflation would remain abnormally low through 2010 and possibly into 2011.
Their longer-run projection called for inflation of 1.7% to 2%, well above the 2009 forecast for 0.3% to 1% and an indication of the inflation rate officials would like to achieve.
“The longer-term projections of inflation may be interpreted ... as the rate of inflation that FOMC participants see as most consistent with the dual mandate given to it by Congress -- that is the rate of inflation that promotes maximum sustainable employment while also delivering reasonable price stability,” Fed Chairman Ben Bernanke told the National Press Club.
Anchoring expectations
Taking on-the-record media questions for the first time since becoming Fed chairman in 2006, Bernanke said the long-run projections should help anchor public expectations about the future path of inflation in a way that could help prevent a self-reinforcing inflationary, or deflationary, psychology.
Deflation, a period of sustained price declines, is seen as dangerous to the economy because it can cause businesses and consumers to delay purchases in the hopes of securing even lower prices, which would worsen the recession.
When Bernanke took the helm at the Fed, he was a vocal proponent of setting a numerical target for inflation. However, some officials have worried that establishing an explicit target would limit the central bank’s flexibility.
With policy-makers increasingly concerned that falling prices will trigger a dangerous round of deflation and prolong the recession, some economists had speculated the Fed would extend its forecast horizon in a compromise move.
The minutes showed that Fed officials held a 16 Janueary conference call where they discussed establishing an explicit inflation target, various inflation gauges that they could use and related issues, but no decision was made.
Charles Evans, president of the Chicago Federal Reserve Bank, said on Wednesday that “tremendous resource slack” could pull inflation down to 1 percent, although he said it would require a larger contraction than he expects for deflation to take hold.
Bernanke on Wednesday disclosed no new programs to aid the economy. Nor did he mention buying longer-dated Treasury debt, which he discussed in January as a way to ease borrowing costs but has made no public mention of since.
Some observers think the Fed is backing off the idea.
They also considered ways they could better convey their thinking on monetary policy when rates are likely to remain near zero for a while. Some FOMC members thought establishing targets for growth of the money supply could provide useful information and help anchor inflation expectations.
Bernanke dismissed worries that expanding the Fed’s balance sheet would stoke inflation, pointing out that with global economic activity so weak and commodity prices low, there was little risk of unacceptably high inflation in the near term.
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First Published: Thu, Feb 19 2009. 11 47 AM IST