Economic signs change; Fed policies do not

June 21, 2011

The Federal Reserve concludes its latest policy meeting Wednesday amid a starkly different economic backdrop from its sessions in recent months.

Growth is slumping in the United States, and the rumbling European debt crisis has raised the risk of a new financial crisis. And commodity prices, which were spiking earlier in the year, have now ebbed.

The economic environment may be changing, but the Fed’s policies probably won’t. While Fed officials are concerned about the ominous signs in the economy, they still expect growth to pick up in the second half of the year. And with their controversial effort to pump $600 billion into the economy expiring in mere days, they see little wisdom in expanding the program anew.

As such, the real news following the two-day meeting will be not in the form of action, but in words and numbers: How will Fed officials describe their view of the economy and inflation risks in their statement following the meeting? How will they quantify those views in new economic projections? And what tone will Chairman Ben S. Bernanke project in a news conference following the meeting?

The central bank is sure to acknowledge the recent slowing in the pace of growth, but the question is how strongly they hold to the view, articulated by Bernanke in a speech earlier this month, that they view many of the causes of weak 2011 growth so far to be temporary.

Fed officials are likely to downgrade their forecast for 2011 growth in gross domestic product for the second straight meeting. As of April, they expected the economy would grow in the 3.1 to 3.3 percent range for the full year, and that range will now probably dip into the high 2 percent range.

Perhaps more interesting will be whether Fed leaders adjust their view of 2012 growth. In April, top officials of the central bank expected the economy will accelerate to 3.5 to 4.2 percent growth next year, climbing out of its deep hole. It will be telling if the weak data over the last couple of months on housing, jobs and even industrial output made them rethink that assumption even a little bit.

Wednesday afternoon, Bernanke will conduct his second quarterly news conference, continuing a practice begun in April. He will probably face questions on whether the Fed will consider a new round of bond purchases to try to combat the economic weakening, as some in the financial markets expect. But neither Bernanke nor any of his colleagues at the Fed have given any indication that they believe a new multibillion-dollar program to try to prop up growth would be a good idea given that growth remains intact and higher fuel prices have begun to bleed through to higher underlying inflation.

Bernanke also probably will be asked about the European debt crisis and any ramifications for the United States. While there is little the Fed can do about a possible default on Greek government debt, the Fed could weigh extending a special program to make dollars available to other leading central banks.

In May of last year, when the Greek debt problems were flaring up, the Fed extended these “swap lines” to the European Central Bank, the Bank of England and other overseas central banks to make sure they could in turn lend dollars to banks in their countries should conditions become stressed. Those swap lines are scheduled to expire Aug. 1, and the Fed probably will consider extending them further.

That would help deal with one risk emerging from the Greek financial crisis — that investors will be reluctant to keep lending money to European banks that could be exposed to losses, causing a freeze-up of the credit system like that in 2008. The swap lines help reduce that risk.

“The Fed has a pretty low bar for extending these swap lines,” said Michael Feroli, chief U.S. economist at J.P. Morgan Chase, adding in a research note that the central bank may not announce an extension alongside its monetary policy announcement Wednesday, as the Fed has in the past announced such actions separately.

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