Fed Dampens Outlook for 2008

Ben S. Bernanke, chairman of the Federal Reserve, announced last week that the policymaking board will be more transparent in its projections.
Ben S. Bernanke, chairman of the Federal Reserve, announced last week that the policymaking board will be more transparent in its projections. (By Carol T. Powers -- Bloomberg News)
By Neil Irwin
Washington Post Staff Writer
Wednesday, November 21, 2007

Leaders of the Federal Reserve expect the U.S. economy to slow in 2008 and believe there are higher-than-usual risks that the economy will perform worse than they forecast.

Fed policymakers project the economy to grow 1.6 to 2.6 percent in 2008, according to a range of forecasts they released yesterday.

In June, their 2008 growth forecasts ranged from 2.5 to 3 percent.

"There is still a lot of uncertainty, and they may be hedging their forecast on the downside, anticipating some bad news," said Dean Croushore, a University of Richmond economist who wrote a textbook with Fed Chairman Ben S. Bernanke.

The forecasts came as other data showed continuing risks to the economy on all sides. Mortgage finance company Freddie Mac reported horrible financial results, exposing the possibility that the housing market will get even worse. Heating oil prices rose to all-time highs on futures markets, as did crude oil (which settled at $98.03 per barrel for January delivery), and the dollar hit an all-time low against the euro. Higher oil prices and a weaker dollar could cause inflation.

The Fed's detailed projections were released under a policy of greater openness that Bernanke announced last week. The 19 top decision makers at the central bank -- seven governors and 12 regional bank presidents -- will offer their expectations for growth, unemployment and inflation every three months, starting with yesterday's release. (Currently, there are only five governors, because of vacancies.)

"Most participants viewed the risks to their [gross domestic product] projections as weighted to the downside," a statement from the central bank said in describing the policymakers' views. "Participants were concerned about the possibility for adverse feedbacks in which economic weakness could lead to further tightening in credit conditions, which could in turn slow the economy further.

"The potential for a more severe contraction in the housing sector and a substantial decline in housing prices was also perceived as a risk to the central outlook for economic growth," the statement continued. It noted, however, that the U.S. economy has proven resilient during past periods of financial distress.

The policymakers' projections for inflation in 2008 ranged from 1.7 to 2.3 percent. That represents a drop from the 2.7 to 3.2 percent range expected for inflation this year -- apparently reflecting a view that food and energy prices will not keep rising at their recent extraordinary pace.

From 2008 to 2010, Fed leaders predict core inflation, meaning inflation excluding food and energy prices, to be about the same as total inflation. That suggests they expect fuel prices to rise at roughly the same rate as other items in the economy.

For the first time, the Fed released projections three years out. Armed with those projections, economists can judge what level of inflation the Fed is targeting, and what levels of economic growth and unemployment it thinks are sustainable.

As for inflation, the "central tendency," or center of the range of Fed leaders' projections for 2010, is 1.6 to 1.9 percent. That means that the central bank is trying to adjust interest rates to keep inflation within that band over the long term.

Their consensus range projections for overall economic growth in 2010 is 2.5 to 2.6 percent, which apparently is the rate that Fed leaders think that the economy can grow over time without sparking inflation.

That is a bit lower than many private economists' view of how fast the American economy can grow, an estimate based on such factors as the rate of technology improvements and population growth.

The consensus range for the 2010 unemployment rate is 4.7 to 4.9 percent, meaning policymakers think unemployment can hover at that level without fueling inflation. Earlier this year, unemployment was 4.5 percent, and it now stands at 4.7 percent.

The Fed also released minutes of its Oct. 31 policymaking meeting, where it decided to cut a short-term interest rate by a quarter percentage point. The minutes indicated that the decision was a "close call."

What seemed to tip the balance in favor of cutting rates, the minutes said, was a worry that tighter lending conditions were counteracting the stimulus to the economy from the earlier rate cut, and a desire to have "insurance" against worsening economic news.

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