Fed Forecasts Faster Growth as Economy Improves

Fed Forecasts Faster Growth as Economy Improves

By SEWELL CHAN
Published: February 16, 2011
Article from: NYTimes.com

WASHINGTON — The Federal Reserve revealed Wednesday that its policy makers had substantially upgraded their forecasts for how much the United States economy will grow this year, though they expect unemployment to remain painfully high for some time.

Top Fed officials now expect the output of goods and services to grow by 3.4 percent to 3.9 percent this year, up from the previous forecast, released in November, of 3 percent to 3.6 percent. But their grim outlook for the job market was largely unchanged: 8.8 percent to 9 percent unemployment this year, only one-tenth of a percentage point lower than in the November forecast.

Growth expectations were lifted by an improvement in consumer spending in the fourth quarter, though Fed officials were uncertain how long that would last, according to minutes released on Wednesday of the Fed’s policy meeting in late January.

“On the one hand, the additional spending could reflect pent-up demand following the downturn, or greater confidence on the part of households about the future, in which case it might be expected to continue,” the minutes noted. “On the other hand, the additional spending could prove short-lived, given that a good portion of it appeared to have occurred in relatively volatile categories such as autos.”

At the meeting, the Federal Open Market Committee, the Fed’s main policy arm, voted unanimously to continue a plan announced in November to purchase $600 billion in Treasury securities, the second round of a strategy that is intended to push down long-term interest rates and lift share prices. The strategy, known as quantitative easing, has been controversial — critics say it could set the stage for future inflation and asset bubbles — but the Fed has been fairly unified behind it.

The minutes indicated that Fed officials saw a diminishing risk of deflation, a protracted fall in prices of the sort that has afflicted Japan for more than two decades. That fear of deflation was a principal factor behind the decision in August to set the stage for the bond purchases.

Other economic reports issued on Wednesday supported the Fed’s view of an economy starting to gather some steam. The Commerce Department reported that new home construction rose by the largest amount in 20 months, and the Labor Department reported that wholesale prices rose sharply in January, driven up by gasoline and pharmaceuticals. Excluding the volatile food and energy categories, the index rose by the most in more than two years.

The Federal Reserve’s own report on industrial production in January was more mixed. Factory output rose for the fifth straight month, spurred by strong car and struck sales, but utility and mine output fell, leaving the overall level of production lower, the first month-to-month decline in 19 months.

For their part, investors have been bidding up stock prices steadily since late November. In midafternoon trading, the S. & P. 500 index was about 0.6 percent higher for the day and 6.2 percent higher for the year.

The minutes painted a picture of a committee that was not quite certain about how long and painful the recovery would take from the 2007-9 recession — the longest downturn since the Depression.

“On the downside, participants remained worried about the possible effects of spillovers from the banking and fiscal strains in peripheral Europe, the ongoing fiscal adjustments by U.S. state and local governments, and the continued weakness in the housing market,” the minutes stated. “On the upside, the recent strength in household spending raised the possibility that domestic final demand could snap back more rapidly than anticipated. If so, a considerably stronger recovery could take hold, more in line with the sorts of recoveries seen following deep economic recessions in the past.”

Although food and energy prices have increased recently, especially in fast-growing emerging markets, the committee did not have a consensus on whether that development would lead to higher inflation in the United States, noting that the factors affecting businesses’ ability to pass higher costs through to their consumers were “complex and hard to monitor in real time.”

The minutes noted that most Fed officials viewed the large slack in the economy — that is, the economy’s underperformance relative to its potential — as “likely to remain a force restraining inflation,” and believed that while price declines were unlikely, inflation was likely to remain below its desired level (2 percent or slightly below) “for some time.”

Some participants also said that if the public doubted the Fed’s willingness to reduce its huge balance sheet — by selling the financial assets it acquired as a response to the crisis — when the time comes to do so, “the result could be upward pressure on inflation expectations and so on actual inflation.”

In recent months, the Fed chairman, Ben S. Bernanke, has been adamant in saying that the Fed was ready and willing to curb inflation — and could even raise interest rates at a moment’s notice if it needed to.

The committee’s unanimous vote in January to consider the $600 billion bond-buying program, which is to continue until the end of June, surprised some observers, because a small but vocal minority on the committee had questioned the need for the program. But the minutes revealed that for now, the committee was unified on continuing the purchases, viewing the risks to doing so as manageable.

“A few members noted that additional data pointing to a sufficiently strong recovery could make it appropriate to consider reducing the pace or overall size of the purchase program,” the minutes stated. “However, others pointed out that it was unlikely that the outlook would change by enough to substantiate any adjustments to the program before its completion.”