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Fed Leaders Issue Bleak Forecast

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By Neil Irwin and Annys Shin
Washington Post Staff Writers
Thursday, February 19, 2009

It could take years for the nation to fully bounce back from the recession, according to new projections by leaders of the Federal Reserve, who indicated that even once the economy starts expanding again, it will be an "unusually gradual and prolonged" recovery.

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The unemployment rate will remain elevated through at least 2011, according to the policymakers' official forecast, released yesterday, and the economy this year could shrink by 1.3 percent. That would mark the sharpest contraction in 27 years.

The bleak outlook suggested a deep sense of gloom among the top policymakers at the central bank and offered insight into why they have moved aggressively to bolster the financial system and soften the recession's blow.

Fed leaders agreed that unemployment would remain high for the next three years, "even absent further economic shocks," according to the minutes of the Fed's late January policymaking meeting. "A few [members] indicated that more than five to six years would be needed for the economy to converge to a longer-run path" of growth.

Fed Chairman Ben S. Bernanke appears not to be among that highly pessimistic group. After a speech yesterday, he told reporters that although the unemployment rate is "very likely" to rise from its current 7.6 percent level to "above 8," government action can contain the damage.

"If we can take strong and aggressive action, including the Fed's actions, to try to improve credit markets, I think we can break the back of this thing and that we will begin to see improvements in 2009," Bernanke said. But he warned, "If we fail to take adequate actions, the situation would continue to deteriorate."

The Fed releases projections by its seven governors and 12 regional bank presidents four times a year. The forecast for the next three years is affected by the current downturn to such an extent that the central bank yesterday released a new projection, for the longer-term jobless rate, pace of growth and inflation.

The decision was a tacit admission that one must now look more than three years ahead to get an adequate handle on Fed leaders' targets for inflation and growth -- targets that help determine what kind of policies to enact. Additionally, by releasing longer-term projections, the Fed was inching closer to an "inflation target," a stated goal for what annual price increases would be optimal in the long run.

Leaders of the central bank are particularly worried about a cycle of falling prices, known as deflation. An explicit target of about 2 percent might help prevent such a cycle from developing. The move yesterday was "an attempt to raise inflation expectations," said Michelle Meyer, an economist at Barclays Capital. "We can expect continued aggressive action," she said.

The Fed leaders believe that the optimal inflation level over time is 1.7 to 2 percent, according to the projections.

Over the past year, the officials have repeatedly proved too optimistic in their outlook for the economy. For example, in October, they forecast that the jobless rate would be 6.3 percent to 6.6 percent by the end of 2008. By December, the rate was 7.2 percent.

Meanwhile, grim economic data continue to pour in. Yesterday, the Fed announced that industrial production, a crucial measure of the economy, dropped 1.8 percent in January, a larger-than-expected decline.


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