Economic recovery moving at a slower pace, but Fed sees stimulus as potentially risky

By Neil Irwin
Washington Post Staff Writer
Thursday, July 15, 2010

Federal Reserve leaders have marked down their expectations for growth and inflation, concluding that the economic recovery is proceeding more slowly than they had thought in the spring but that the slowdown did not warrant new policy actions.

But the Fed leaders did agree to explore options for supporting the economy further in case conditions worsen.

Most members of the Fed policymaking committee remain reluctant to take any new steps to try to encourage growth despite the softer outlook, given that the Fed's interest rate target is already near zero. They view the remaining options to try to stimulate growth as risky and potentially ineffective, and continued economic expansion to be the most likely scenario.

But if the recovery continues to stumble -- data released this week suggest that the economy grew at a rate of just over 2 percent in the April through June quarter, not the 3 to 3.5 percent previously thought -- pressure will grow on the Fed to do something about it.

"The changes to the outlook were viewed as relatively modest and as not warranting policy accommodation beyond that already in place," said minutes of the Fed's June 22-23 policy meeting, released along with revised economic forecasts. "However, members noted that in addition to continuing to develop and test instruments to exit from the period of unusually accommodative monetary policy, the Committee would need to consider whether further policy might become appropriate if the outlook were to worsen appreciably."

In forecasts made in advance of the meeting and released Wednesday, the officials expected that gross domestic product will grow 3 to 3.5 percent this year, compared with a forecast of 3.2 to 3.7 percent at their April meeting. They modestly downgraded their projection for 2011 as well.

That lower growth could translate into unemployment staying higher for longer -- Fed leaders expect the jobless rate to be 9.2 to 9.5 percent in the fourth quarter, and to still be 8.3 to 8.7 percent at the end of 2011, both slightly higher than in April forecasts.

But they see little threat from inflation, forecasting that prices will rise 1 to 1.1 percent this year, compared with the 1.2 to 1.5 percent rate forecast in April. The new forecast is well below the 1.7 to 2 percent inflation rate that the Fed targets over the longer term.

The forecasts are the most explicit confirmation to date that Fed officials have lowered their expectations for growth. Since that meeting three weeks ago, more weak economic data have been released suggesting a deceleration in the economy, including reports on June employment conditions, international trade in May and retail sales in June.

Still, the minutes make clear that Fed leaders still anticipate a continued economic recovery, suggesting that most of the policymakers would still resist any push to take new steps to support growth.

Members of the policymaking committee "generally saw the incoming data and information received from business contacts as consistent with a continued, moderate recovery in economic activity," the minutes said.

The minutes did note that "financial markets had become somewhat less supportive of economic growth," mainly due to troubles in Europe, and that this was "likely to weigh to some degree on household and business spending over coming quarters."

But the officials appear to place greater weight on data suggesting strength in the business sector. They noted that investment in equipment and software was rising rapidly, and that household spending "continued to advance," even as the weak job market could weigh on consumers.

Fed leaders are starting to discuss policies that they might use to further support growth if the economy continues to weaken, including pledging to keep interest rates low for even longer than now expected, cutting the interest rate on banks' reserves, and buying some additional mortgage securities.

If the economy began to contract, or appeared at serious risk of doing so, Fed leaders could consider more aggressive steps, namely large-scale purchases of Treasury bonds or mortgage backed securities, strategies to increase the money supply and reduce long-term interest rates.

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