The unemployment rate has declined notably in recent months but remains elevated… household spending and business fixed investment have continued to advance. The housing sector remains depressed… Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook, says the Federal Open Market Committee statement, released March 13.
The Fed tempers three encouraging observations with three warnings, thereby allowing themselves maximum leeway if the economy warrants stimulus down the road. To that same purpose, the bank says inflation shouldnt be a concern in the long run. While acknowledging that rising oil prices will push up inflation in the near term, it writes that subsequently inflation will run at or below the rate it judges most consistent with its dual mandate.
Economists say that what may especially be tripping up the Fed are signs from the latest jobs and gross domestic product reports. As of Februarys unemployment report from the government, the economy has added more than 200,000 jobs for three months in a row, an upbeat sign for a central bank whose job is to push down the unemployment rate. However, economists dont get excited about long-term employment prospects unless consistent jobs creation comes hand in hand with broader economic growth. And so far, the latter is less than inspiring.
Research firm Macroeconomic Advisers forecasts that the economy will expand by 2.6% this year, with the pace slowing to 2.3% in the first half before picking up to 2.9% in the latter half. In comparison, 2011 saw a strong pattern of acceleration each quarter — 0.4%, 1.3%, 1.8% then 3%.
Despite better economic data this year, forecasts have fallen compared to projections made in 2011. The Fed, too, has cut its 2012 forecast from last June to a range of 2.2% to 2.7%.
The annual revisions to the national income and product accounts released last summer indicated that the recovery had been somewhat slower than previously estimated, said Fed chief Ben Bernanke in his semiannual speech before Congress in late February.
In addition, fiscal and financial strains in Europe have weighed on financial conditions and global economic growth, and problems in US housing and mortgage markets have continued to hold down not only construction and related industries, but also household wealth and confidence, he added.
Reasons why GDP projections are lower vary. According to Robert Johnson, economist with Morningstar, some economists say that trade balance got out of hand in January. Export growth was still pretty good but imports went through the ceiling, he says. US consumers can feel wealthier and more Americans can find jobs, but if their incomes go to goods made outside of the US, it doesnt bode well for our own GDP and employment figures, explains Johnson.
While the central bank doesnt explicitly target GDP growth, its monetary actions must jibe with the broadest measure of economic health. Given that not all data points have aligned, the Federal Reserve is careful that it still has further work to do.
The Federal Reserve must try to tackle deep rooted economic challenges with blunt monetary tools that dont necessarily get directly at trouble markets, like jobs or housing. It can easily come running in with quantitative easing for an economy in free fall. But current conditions are far from that serious, which is why it makes sense that the Fed is looking for more pointed ways to help the economy.
The suggestion from the Wall Street Journal is the bank is contemplating a sterilized bond buying program. Some economists argue that is still too blunt or that the strategy isnt significantly different from Operation Twist, the banks latest attempt to help the economy, in terms of controlling interest rates and inflation in tandem. Others say the bank should step out completely from here out, that meddling with the economy will only cause hyperinflation and a run up in asset classes, in particular commodities.
While economists still debate whether there will be a third round of quantitative easing, the discussion over monetary policy has largely shifted to what kind of stimulus, if anything, is appropriate for the current conditions.
Meanwhile a new threat has emerged for the US Its no longer an external shock from Europe, but the new economic uncertainty created by rising oil prices. Earlier this week, Treasury Secretary Timothy Geithner highlighted the struggle with Iran as one of the additional challenges that threaten growth.
Inflation can single handedly alter the grand plan of the Fed to save the US economy, says Peter Boockvar, equity strategist with Miller Tabak, who calls inflation the kryptonite of the Fed.
The European debt crisis may have reached an inflection point in the near term. Hiring has picked up pace. The financial sector looks to be on better footing with most big banks passing the latest stress test. And investors are still riding a stock market rally.
Good economic news will always be good news. But it rarely ever lets the Fed off easily.
– Written by Chao Deng in New York.
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