Fed may accept slow recovery to fight inflation







'If we do in fact see moderate growth, but not growth much more than the underlying potential growth rate, then unfortunately unemployment will be slow to come down,' Ben Bernanke says. AP photo
U.S. Federal Reserve Chairman Ben S. Bernanke, who on Tuesday said the U.S. recession probably has ended, may have to accept a slow recovery and high unemployment as the price for defending his inflation-fighting credentials.
“Even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time,” Bernanke said in response to questions after a speech at the Brookings Institution in Washington. “That’s a challenge for us and all policy makers going forward.”
Policy makers predicted in June that the unemployment rate will remain above 9 percent through the end of next year, while inflation will stay below their preferred range. That hasn’t stopped them from starting to unwind their extraordinary monetary stimulus as investors express concern that the expansion of the Fed’s balance sheet to $2.1 trillion will ignite inflation when the economy recovers.
“The Fed is in an odd situation here,” said Michael Feroli, an economist at JPMorgan Chase in New York. “Both aspects of their dual mandate for growth and inflation will have suboptimal outcomes, but they can’t do anything to speed things up because of concerns about inflation credibility.”
The Federal Open Market Committee, or FOMC, may extend the end-date of its $1.45 trillion program to buy housing-agency and mortgage-backed securities at its next meeting Sept. 22-23. There is little chance that it will expand the program after deciding in August to end purchases of $300 billion in Treasury debt next month.
Greenspan worried:
Former Fed Chairman Alan Greenspan said he’s worried that lawmakers will hamper central bank efforts to rein in its monetary stimulus, and that inflation might “swamp” the bond market.
“It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said. He also said that “if inflation rears its head, it will swamp long-term markets,” referring to bonds.
Central bankers have pledged to keep the benchmark lending rate in a range of zero to 0.25 percent “for an extended period.” If unemployment lingers at high levels, officials could face questions on whether they have done enough to push the economy to a faster rate of growth, economists say.
“At the end of 2010, the story may not be whether they exited correctly, but how did they allow this outcome to occur,” said Laurence Meyer, a former Fed governor and vice chairman of Macroeconomic Advisers. “The definitive marker of the end of easing was the decision at the August FOMC meeting to allow Treasury purchases to expire.”
The FOMC’s June forecasts show unemployment above 8 percent in the final three months of 2011. A majority of FOMC members also forecast inflation will be below their long-run preferred range of 1.7 to 2 percent next year, Fed minutes show.
“If we do in fact see moderate growth, but not growth much more than the underlying potential growth rate, then unfortunately unemployment will be slow to come down,” Bernanke said Tuesday, noting that the economy faces “headwinds” such as tight credit. “It will come down, but it will take some time.”
At the same time, the Fed could startle markets if it decided to buy up more government debt, expanding the balance sheet even further. Gold futures reached an 18-month high of $1,013.70 an ounce on Sept. 11 as the U.S. Dollar Index, which values the greenback against six other currencies, dropped to its lowest level in almost a year.
Inflation concerns:
“Those buying gold believe the Fed is going to be accepting inflation if not even promoting it,” said Axel Merk, whose $370 million Hard Currency Fund is up 11.3 percent year to date on investments in precious metals and foreign currencies.
Yields on the 10-year Treasury note rose for a second day Tuesday after a report from the Commerce Department showed that retail sales surged in August by the most in three years, adding to evidence the economy is recovering. The yield on the 10-year note rose to 3.46 percent at 5:32 p.m. in New York from 3.42 percent the day before.
The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 1.84 percentage points from 1.66 percentage points two weeks ago. It has averaged 2.19 percentage points over the past five years.
David Simon, chairman and chief executive of Simon Property Group, the largest U.S. shopping mall owner, said “It’s too early for us to declare the recession over.”
“Ultimately, what’s important to retail and real estate is the health of the consumer, the job outlook and so on,” Simon said in an interview, when asked to respond to Bernanke’s comments. “I still think the consumer is under pressure.”