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Fed’s forecast for economy gets gloomier

Federal Reserve policymakers are forecasting slower economic growth, higher unemployment and higher inflation.
/ Source: The Associated Press

Even Federal Reserve policymakers recognized it: Their huge double dose of medicine for the sickly economy was not a cure.

On Wednesday, the Fed downgraded its expectations for economic growth this year, citing damage from the housing slump and credit crunch. It said it also expects higher unemployment and inflation.

Fed Chairman Ben Bernanke and his colleagues are concerned the economy could continue to weaken, even after their aggressive interest rate cuts last month. In their words, “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. The minutes were released Wednesday.

At that session, the Fed policymakers voted to cut a key interest rate by one-half percentage point to 3 percent. Just eight days earlier, in an emergency session, they had slashed the rate by a rare three-quarters percentage point. The two cuts together marked the most dramatic reductions in a single month by the Fed in a quarter century.

Under its new economic forecast, the Fed said it now believes the gross domestic product will grow between 1.3 percent and 2 percent this year. The previous forecast was for growth between 1.8 percent and 2.5 percent.

GDP is the value of all goods and services produced within the United States and is the best barometer of the country’s economic fitness.

With the economy slowing, the Fed projected that the jobless rate will rise to between 5.2 percent and 5.3 percent this year. The old forecast was for the rate to climb as high as 4.9 percent. Last year, unemployment averaged 4.6 percent.

And, with energy prices heading upward, the Fed also raised its projection for inflation. It now expects inflation to be between 2.1 percent and 2.4 percent this year, up from the previous forecast of 1.8 percent to 2.1 percent.

The Fed said the revisions reflected factors including “a further intensification of the housing market correction, tighter credit conditions ... ongoing turmoil in financial markets and higher oil prices.”

The combination of slower economic growth and increasing inflation could complicate the Fed’s work. The central bank’s remedy for a weakening economy is interest rate cuts. To combat inflation, the Fed usually boosts rates.

Oil prices on Wednesday climbed to a new record — topping $100 a barrel. Consumer prices, meanwhile, rose by a bigger-than-expected 0.4 percent in January, according to new government figures.

While some believe inflation concerns could lead the Fed to cut rates by a modest one-quarter percentage point at its next meeting on March 18, many are still predicting another half-point reduction.

“Job No. 1 at the Fed is to right this potentially sinking ship even as inflation continues to percolate,” said Richard Yamarone, economist at Argus Research. He and other economists believe the Fed is sending a message that the risk of recession outweighs the danger of inflation — for now, anyway.

On Wall Street, the hope of more rate cuts lifted stocks. The Dow Jones industrials closed up 90.04 points.

Fed policymakers were mindful that they needed to keep a close eye on inflation, minutes of the Jan. 29-30 meeting said.

And, several noted that when prospects for economic growth improved, “a reversal of a portion of the recent easing actions, possibly even a rapid reversal, might be appropriate,” according to the documents.

Still, all but one of the Fed’s members agreed to lower rates by a half-point at that time.

Richard Fisher, president of the Federal Reserve Bank of Dallas was the sole dissenter. He preferred no change, believing the level of interest rates was already “quite stimulative, while headline inflation was too high.”

For next year, the Fed expects economic growth to pick up a bit and for inflation to moderate. The unemployment rate could ebb to 5 percent or hover as high as 5.3 percent, according to the Fed’s forecast.

The minutes also showed that the Fed conducted a conference call on Jan. 9 as policymakers reviewed economic data and financial market developments, which were worsening. They did not lower interest rates at that time, although most policymakers were of the view that “substantial additional policy easing in the near term might well be necessary” to help brace the wobbly economy.

As the financial situation continued to deteriorate, worldwide stock markets plunged and recession fears intensified, Bernanke convened an emergency conference call on Jan. 21. The Fed decided to slash rates by the dramatic three-quarters of a point and make the announcement on the following morning, Jan. 22.

Demonstrating the Fed’s “commitment to act decisively” might reduce concerns that seemed to be contributing to the worsening state of financial markets, according to the minutes. However, there was some concern expressed that such a bold move “could be misinterpreted as directed at recent declines in stock prices, rather than the broader economic outlook,” the documents showed.

William Poole, president of the Federal Reserve Bank of St. Louis, was the lone dissenter on the Fed rate cut announced on Jan.

22. He did not believe conditions justified a cut before the regularly scheduled meeting on Jan. 29-30, the minutes said.