Fed warns on economic outlook, and cites deflation fears

Federal Reserve policymakers are expecting the economy to continue to contract through the first half of 2009, and possibly beyond that point, according to the minutes of their last meeting.

They also all but confirmed that they’ll cut their benchmark interest rate again, even though it’s already at a mere 1%.

From the Oct. 28-29 meeting minutes, released today:

Participants generally expected the economy to contract moderately in the second half of 2008 and the first half of 2009, and agreed that the downside risks to growth had increased. While some expected an improving financial situation to contribute to a recovery in growth by mid-2009, others judged that the period of economic weakness could persist for some time.

Participants saw the potential for financial strains to intensify if some investors, such as hedge funds, found it necessary to sell assets and as lending institutions built reserves against losses. Participants were concerned that the negative spiral in which financial strains lead to weaker spending, which in turn leads to higher loan losses and a further deterioration in financial conditions, could persist for a while longer.

As for the next likely move with interest rates:

Members anticipated that economic data over the upcoming inter-meeting period would show significant weakness in economic activity, and some suggested that additional policy easing could well be appropriate at future meetings. In any event, the committee agreed that it would take whatever steps were necessary to support the recovery of the economy.

The Fed also nodded to its fears about a potential broad-based deflation of prices: "Some saw a risk that over time inflation could fall below low levels consistent with the Federal Reserve's dual mandate of price stability and maximum employment," according to the minutes. That's code for deflation.

Some Fed officials felt that "more aggressive easing should reduce the odds of a deflationary outcome."

The government today reported that the consumer price index slid 1% in October. Even excluding food and energy costs, the index was down 0.1%.

A little deflation is a good thing; a lot would be an economic catastrophe. Think Japan 1995-2005. See my recent column on deflation risks, here.

Comments

[tom thumb]

this is biggest and most blatant robbery in our nation's history.

the rich have the resources to play the crisis both ways and will suck even more money from everybody else. rich private individuals have completely looted and pillaged american citizens, the government, publicly held companies, and retail investors.

this is criminal. the executives of the nation's largest banks and the managers of most hedge funds need to be thrown in jail. as do greenspan, bernanke, paulson, and the rest of the administration. it is unfathomable to me that the SEC and federal government are letting this occur. i really can't believe this is happening.

this entire crash and recession have been caused by financial manipulation and terrorism, both foreign and domestic.

[Cesar]

I think the US should minimize spending in many things such as in Iraq (pull troops or whatever necessary) to get some money for use in the US. We have seen that the Iraq situation has dragged too long and made the US spend too much. Other programs should be placed on hold or cancelled. The US space program should be reduced in hard times. High spending in non-essential matters should be cut down / reduced drastically as needed. There is a lot of miss-spending.

Is there something we could change so that poor presidents get taken down sooner, not 3 or 4 years later? The way we choose our president should be revamped. Obviously we are not choosing the best candidates. Can the congress enact a law that can take poor performing presidents and other government officials down such as calling for a vote by the people?

Cesar

[Boris86]

The only reason there's deflation is because energy costs have fallen. Just like the only reason there was inflation in the summer was because energy costs rose. There's no need to over analyze or be alarmed. Incredible.

[Tom Petruno]

Boris86: The easing of price pressures was quite pronounced in many goods and services sectors from August to October, including clothing, food, household furnishings, medical care and recreation. It wasn't just energy.
You can look for yourself here:

http://www.bls.gov/news.release/cpi.t01.htm

The Fed will be happy if this is just disinflation. But I assure you they don't want to see full-scale deflation break out. And with the economy in very bad shape, they know deflation is a significant risk.

Tom Petruno

[martscan]

I couldn't agree with deflation fears more. We certainly have all the ingredients for a perfect deflationary recipe. Weakening global economies, decreasing inflation rates (save Zimbabwe), rising unemployment, rising govt debt, declining aggregate demand, the ongoing housing bust, incredible excess capacity and mountainous debt, decreasing collateral values and increased credit restrictions...and a finite, corrective monetary policy at the end of the string....as Keith Jackson was wont to say, 'whoa Nellie!' There is nothing in history that says we couldn't emulate Japan's decade long malaise.

[Mr.Bilko]

Tom wrote: "http://www.bls.gov/news.release/cpi.t01.htm

The Fed will be happy if this is just disinflation. "

This is a: Is the glass half-empty or is the glass half-full scenario.

According to the table, from Oct.07 to Oct.08, inflation was 3.7%. From Jul.08 to Oct.08, inflation was -1.1%. What this extrapolates to is that inflation from Oct.07 to Jun.08 was 4.8%. 4.8% is encroaching on the low end of 1970s era inflation territory. Couple that 4.8% inflation with GDP at less than 1.5% (see: http://www.bea.gov/newsreleases/national/gdp/gdphighlights.pdf ) and you have stagflation.

So, is it stagnation? Or is it deflation? If you consider the last 18 months, the answer is stagnation. If you only look at the last three months, then it's deflation.