Stagflation threat haunts Fed
BARRIE MCKENNA
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February 20, 2008 at 6:16 PM EST
WASHINGTON — Inflation has become the pesky problem that just won't go away, even as the U.S. economy falters.
The U.S. Federal Reserve Board tacitly acknowledged the threat of stagflation – a toxic mix of inflation and meagre growth – in its new economic forecast, released Wednesday along with minutes of recent bank meetings.
The latest inflation numbers complicate the Fed's job of trying to avert a recession. Prices were 4.4 per cent higher in January than a year ago, pushed up by soaring food and energy costs.
The Fed's main concern is that the economy will slow even more, in spite of the quickest injection of interest rate relief in two decades.
Federal Reserve Board Chairman Ben Bernanke
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Fed issues far gloomier outlook
“With no signs of stabilization in the housing sector and with financial conditions not yet stabilized, the committee agreed that downside risks to growth would remain even after this action,” according to minutes of the Fed's Jan. 29-30 closed-door meeting. (At the meeting, the bank cut its benchmark rate by half a percentage point to 3 per cent).
Fed officials said rates might have to stay “relatively low” for some time, the minutes said.
At the same time, the Fed expects inflation will remain above its comfort zone throughout the year.
The Fed is bracing for higher core inflation this year (2 to 2.2 per cent compared with an earlier estimate of 1.7 to 1.9 per cent), slower growth (1.3 to 2 per cent compared with 1.8 to 2.5 per cent) and higher unemployment (5.2 to 5.3 per cent compared with 4.8 to 4.9 per cent). Its previous forecast was in October.
The last time the economy grew at a rate of less than 2 per cent was in 2002 and 2001. The U.S. suffered a mild recession in 2001.
Speaking in Missouri Wednesday, St. Louis Fed president William Poole said the Fed would be wrong to ignore inflation as it fights to stave off recession.
“My reading of economic history is that we generally live to regret a monetary policy focused exclusively on the No. 1 economic concern of the day,” he said.
Many economists now say the U.S. is either already in a recession or dangerously close to one. The Fed continues to believe otherwise.
Mr. Poole stopped short of predicting a full-blown recession, typically marked by two consecutive quarters of shrinking economic output.
But he said the months ahead may feel like a recession. “The difference … 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,” Mr. Poole said.
The threat posed by inflation was evident is the latest U.S. inflation numbers. Prices unexpectedly shot up 0.4 per cent in January, pushed higher by surging energy and food costs, according to the U.S. Labour Department's monthly consumer price index (CPI) released Wednesday.
Prices are now rising at an annual rate of 4.4 per cent – the fastest pace since the fall of 2005, when hurricane Katrina disrupted U.S. oil output.
Persistent inflation puts the Fed in a tight spot as it struggles to prop up the faltering U.S. economy with interest rate relief. The central bank has already slashed its benchmark federal funds rate five times since last summer – to 3 per cent from 5.25 per cent.
Most economists expect the Fed's policy-making committee to cut rates again when it meets March 18. But nagging inflation could trigger more dissent among the bank's governors, forcing it to move more cautiously than Fed chief Ben Bernanke would like.
“While the Fed will continue to ease in March, the CPI report puts the committee in a difficult position and makes another aggressive move … less likely,” remarked Peter Kretzmer, senior economist at Bank of America.
The minutes also disclosed for the first time that the Fed held an emergency conference call Jan. 9, but opted to do nothing. The Fed cut rates by three-quarters of a percentage point after a second emergency conference call Jan. 20.
January marked the fifth successive month that overall inflation was greater than less volatile core prices, which exclude food and energy prices.
Core inflation was 0.3 per cent in January and up 2.5 per cent from a year ago.
Most troubling in the report is that the higher price of oil, which has now topped $100 (U.S.) a barrel, has begun to push up other prices. And that's expected to weigh heavily on U.S. consumers, who are already grappling with falling home values and a stock market correction.
“U.S. households are being hit left, right and centre,” said National Bank Financial analyst Stéfane Marion. “As if declining home prices and deteriorating labour markets were not enough, higher inflation is kicking in with a vengeance to further erode purchasing power.”
Virtually everything consumers buy was more expensive in January, including clothing, hotel rooms and medical care. |
