Fed Reins in Growth Forecast

By Neil Irwin
Washington Post Staff Writer
Thursday, February 21, 2008

The Federal Reserve yesterday slashed its forecast for the country's economic growth as fresh evidence showed that prices for a wide range of goods are soaring. The twin announcements crystallize the challenge facing the central bank as it tries to prevent a recession without letting inflation get out of hand.

The Fed has been focused this year on the first concern, as the bank has rapidly cut interest rates to keep the economic downturn from becoming severe.

But the elevated reading on consumer prices, coupled with oil prices that yesterday hit a new high of $101.32 per barrel, could leave the Fed with less flexibility to cut rates aggressively down the road, economists said.

"You have growth expectations declining at the same time that inflation is pouring out of the spigots," said Richard Yamarone, chief economist at Argus Research. "The Fed is painting itself into a corner here."

The forecasts for economic growth in 2008 from 17 top Fed officials range from 1 to 2.2 percent. In October, that range was 1.6 to 2.6 percent. Even that lowered projection does not indicate a recession. They also increased their consensus forecast of the unemployment rate.

Many of the Fed governors and regional bank presidents attributed the sub-par growth expectation to "a deepening of the housing correction, tighter credit conditions . . . and higher oil prices," according to narrative summary of the policymakers' predictions.

Many of the products Americans buy are getting more expensive. Prices for consumer goods rose 0.4 percent in January, the Labor Department said yesterday, and are up 4.3 percent in the past year. Fed leaders aim to keep long-run inflation under 2 percent but acknowledged yesterday that prices are likely to rise faster than that in 2008. Their projections now range from 2 to 2.8 percent, higher than in October.

The rise in food and energy prices was particularly steep, as it has been for many months. There were also price increases for products and services with little connection to those areas. Apparel prices rose sharply, as did medical care, education costs, and rent.

It appears that higher fuel and food prices, both of which have soared in the past year, could be affecting other types of products. Meanwhile, aggressive interest rate cuts and a slowing U.S. economy have led the value of the dollar to fall against other currencies in the past six months, making imports more expensive.

"It's probably some combination of energy prices and import prices percolating through to everything else in the economy," said Bill Cheney, chief economist of John Hancock Financial.

As the economy slows, that combination creates a potentially toxic mix for American consumers of higher prices and slower growth in the number of jobs and wages. It could even be a milder version of the stagflation, or stagnant growth mixed with inflation, that crippled the nation's economy in the 1970s.

That would be a central banker's worst nightmare. For the Fed, it would be a failure to maintain either part of its "dual mandate" ordered by Congress of maintaining low unemployment and price stability.

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