Fed’s rising growth, falling inflation are wishful

April 25, 2012

By Martin Hutchinson
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Ben Bernanke seems to be just hoping for the best. Wednesday’s Federal Open Market Committee statement talks about a pick-up in growth even as inflation declines from the current run-rate above the Federal Reserve’s 2 percent target. These trends aren’t apparent from recent data, and the U.S. central bank needs contingency plans if things don’t pan out so conveniently.

The Fed’s expectation that growth, though now subdued, will gradually build seems inconsistent with the latest report on U.S. durable goods, which showed orders down 4.2 percent – and with relatively weak employment data for March. Furthermore, Fed Chairman Bernanke acknowledged the headwind facing the U.S. economy with the expiry of tax cuts enacted in 2001 and 2003 and the start of spending cuts mandated by the debt ceiling deal in Congress last August.

On the inflation side, inflation measured using personal consumption expenditures was 2.3 percent in the year to February and core PCE inflation, excluding food and energy, was 1.9 percent. The FOMC’s forecast, which ranges upwards to about 2 percent, appears optimistic particularly as quickening growth would normally lead to an acceleration in inflation.

Energy prices could provide a caveat. If oil gets cheaper in the United States, joining domestic gas whose price has been torpedoed by a glut, the U.S. economy could benefit beyond the energy sector, restoring manufacturing jobs and reducing costs in energy-intensive industries. But encouraging large-scale oil drilling isn’t Bernanke’s turf, even if it might help vindicate the Fed’s forecast.

That means the Fed needs contingency plans to deal with lower-than-anticipated growth or unexpectedly high inflation. It’s notable that 10 out of 17 FOMC participants (not all of whom vote each year on policy) expect the federal funds rate to be 1 percent or higher by December 2014 – suggesting that the Fed commitment to keeping rates below 0.25 percent until then is already fading, in reality if not yet on paper. That’s a welcome hint of needed policy flexibility at an uncertain time.

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“Fed’s rising growth, falling inflation are Wishful Thinking..” Ya Think?…you must be an Economist…

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