Fed Leaders Issue Bleak Forecast
Policymakers Project High Unemployment Through 2011, Vow Aggressive Action

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.

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.

The central bank has moved forcefully to blunt the impact of the downturn, in part by establishing unconventional programs designed to make credit more widely available to consumers and businesses. Those efforts have met with skepticism among economists and public officials who fear the Fed is ultimately picking winners and losers in the economy and taking on too much risk. But Bernanke defended the actions yesterday.

"Extraordinary times call for extraordinary measures," he said at the National Press Club in Washington, promising to undo the programs as markets stabilize to avoid inflationary pressures.

In particular, Bernanke responded to calls for more disclosure about what the Fed is doing. The central bank, he said, plans to unveil a new Web site that will pull together information about Fed actions, and an internal committee is reviewing whether any of the information that the central bank usually keeps closely guarded could be made public.

"I firmly believe that central banks should provide as much information as possible," Bernanke said.

But he gave no indication that he is inclined to make public which institutions are borrowing money from the Fed and which assets they are putting up as collateral, as some in Congress have asked the Fed to do. Bernanke has argued that such steps could reduce the programs' effectiveness because institutions would be fearful of using them.

Much commentary on the Fed's new lending has focused on the risk that the Fed could lose money. Bernanke pointed out that the Fed will end up making money from many of the programs.

"All the Federal Reserve's assets pay interest," he said, "and the expansion of our balance sheet thereby implies increased interest income, income that will accrue to the benefit of the federal budget."

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