It is, to use one of former Fed Chairman Alan Greenspan’s memorable words, a conundrum. The Federal Reserve has become more worried that economic recovery is sputtering, but officials don’t want to take action.
The Federal Reserve confirmed Wednesday that its policymakers have lowered their forecast for economic growth and raised their forecast for unemployment. Meanwhile, inflation is actually running lower than they would like.
The latest forecasts call for the economy to grow by 3 to 3.5 percent this year and between 3.5 percent and 4.2 percent in 2011. Unemployment is expected to remain between 9.2 and 9.5 percent this year, and above 8.3 percent next year. Those numbers are only slightly worse than earlier forecasts, but they mask the true extent of the Fed’s growing unease.
That unease becomes clearer in minutes from the Federal Open Market Committee’s June meeting, which were also released. For the first time in months, policymakers agreed on the need to think about “further policy stimulus” in case the outlook gets even worse. They thought financial markets had become “less supportive’’ of growth and worried about spillover from the financial turmoil in Europe. About half of the governors and regional Fed presidents thought that the economy was more likely to be worse than forecast, rather than better.
Yet Fed officials don’t have much appetite for hitting the gas pedal again, and it has never been clear why. The Fed’s “dual mandate’’ requires it to seek both stable prices and full employment.
Usually, that’s a balancing act. Not now. Both inflation and employment are lower than Fed officials would like. Far from being worried that easy-money policies will aggravate inflation, many Fed officials saw risks of even lower inflation and one person even raised the specter of “deflation.”
So why isn’t the Fed trying to pick up the slack? One reason is that inflation hawks on the FOMC are already pushing for tighter policies, and the Fed likes to avoid as much public dissent as possible. The hawks include Jeffrey Lacker, president of the Richmond Fed; Thomas Hoenig of the Kansas City Fed; and Kevin Warsh, a Fed governor in Washington.
But the hawk-dove split isn’t the whole answer. At the end of the day, says Laurence H. Meyer of Macroeconomic Advisers, Fed chairman Ben S. Bernanke “owns the room.”
Bernanke and other Fed officials apparently believe that there are other less obvious dangers to pushing unemployment down rapidly. They may have to do with the practical headaches of reversing the Fed’s massive purchases of long-term Treasury bonds and mortgage securities. They may reflect a fear of triggering inflation years in the future.
It’s just not clear. Bernanke and other Fed officials give many speeches, but they haven’t explained this point.
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