Fed Caught Between Recession, Inflation


MoneyNews
Thursday, Feb. 7, 2008
NEW YORK -- Federal Reserve officials on Wednesday expressed concern about a possible U.S. recession but warned that the central bank cannot let down its guard when it comes to fighting inflation.

"Right now, we're concerned about growth," Richmond Federal Reserve Bank President Jeffrey Lacker told students and faculty at Marshall University's Lewis College of Business in Huntington, West Virginia.

While inflation risks have risen over the past six to eight weeks, the economy will manage to grow at a sluggish rate of about 0.5 percent in the first half of the year, Lacker said.

Since September, the Fed has cut benchmark interest rates by 2.25 percentage points to 3 percent to help the economy weather a deep housing slump and a global credit crunch.

Philadelphia Fed President Charles Plosser said in a speech to the Rotary Club of Birmingham, Alabama, the Fed's aggressive rate cuts will help the economy to return to trend growth of around 2.7 percent by 2009, though he predicted sluggish growth in the first half of 2008.

Story Continues Below

He did not forecast a recession but told reporters after his speech that "if something can tip us into recession, the housing market is the biggest risk."

The stock market fell late on Wednesday as the comments by the Fed policy-makers cast doubt on the outlook for more interest rate cuts. The Dow Jones industrial average closed down nearly 65 points. U.S. government debt prices also fell.

Both men said slower growth does not mean the Fed can take its eye of the ball when it comes to inflation.

"We cannot be confident that a slow-growing economy in early 2008 will by itself reduce inflation," Plosser said.

He said he expects core inflation, which strips out volatile food and energy costs, to remain above 2 percent, "which is above the range I consider to be consistent with price stability."

Lacker also said it was worrisome to see inflation at current levels. The overall consumer price index rose 4.1 percent in the 12 months to December, while the core rate, which excludes energy and food, climbed 2.4 percent.

"We can't cut interest rates as aggressively in response to weakness in growth as we otherwise would," Lacker said. "We're going to be posed with some problems this year if inflation doesn't moderate the way we'd like to see it moderate."

Lacker is not a voting member of the central banks' rate-setting Federal Open Market Committee this year. However, Plosser is a voter, and he endorsed a half percentage point cut to the federal funds rate at the last policy meeting on January 30.

FUTURE RATE CUTS

Lacker did say, though, that it's possible the Fed will have to trim interest rates further to deal with weakening output in the world's largest economy.

"We may cut interest rates again, we may not -- there's a lot of speculation about that," he said.

The FOMC holds its next meeting on March 18, and markets anticipate at least another quarter-point rate reduction.

Federal Reserve Chairman Ben Bernanke is scheduled to testify before Congress on February 14 and is also expected to weigh in on the central bank's outlook

Recent U.S. economic data has been gloomy. Home sales have been steadily falling, while the government said last week the economy shed 17,000 jobs in January.

On Tuesday, data showing the worst monthly contraction in the services sector since the last U.S. recession sent the stock market down about 3 percent its biggest daily drop in nearly a year.

Plosser said weak payrolls growth would continue for most of 2008 and would likely drive the jobless rate up to 5.25 percent from its current 4.9 percent.

But he added that easier monetary policy would not by itself solve all the economy's problems.

He told reporters that lower rates would not solve the problems of bond insurers, who are struggling to hold onto top credit ratings after suffering losses from backing mortgage securities, which have plunged in value over the past year.

He added that the bond insurers' problems "did not directly influence" the Fed's 1.25 percentage points of rate cuts delivered over an eight day span in January.

Bond insurers guarantee over $2.4 trillion of debt.

http://moneynews.newsmax.com/money/arch ... 172516.cfm