Tags: Fed | Keep | eye | Demand | Inflation

Fed Will Keep Eye on Demand Despite Inflation Nod

Friday, 24 September 2010 01:53 PM

Even though the Federal Reserve drew a bright line under its inflation mandate at its meeting this week, officials will remain keenly focused on the strength of demand in deciding whether to ease again.

The Fed edged nearer to giving the wobbling U.S. economic recovery another shot in the arm on Tuesday by saying it stands ready to provide more support, which most analysts expect to come in the form of renewed large-scale asset purchases.

Policymakers broke new ground in their statement by stressing that inflation was running below levels consistent with their congressional mandate to pursue price stability, a nod to worries that an outright deflation could take root.

But the direction of hiring, investment and consumer behavior -- more than price indexes themselves -- will still drive its decision about whether another dose of monetary stimulus is needed.

"It'll be the performance of the employment data, it'll be the performance of all the various measures of demand -- everything from consumer spending, capital spending ... even government spending and inventory behavior," said Charles Lieberman, chief investment officer of Advisors Capital Management in Hasbrouck Heights, New Jersey.

"If the economic data remains as sluggish as it has been over the last few months, then, yes, the Fed will implement another round of quantitative easing," he said.


The Fed said underlying inflation was running at levels "somewhat below" those it prefers, and said it was prepared to pump more money into the economy to support recovery and return inflation to desirable levels.

Many analysts viewed the nod to inflation as a consensus-building effort aimed at winning over inflation-focused hawks at the Fed who believe the central bank can directly influence prices, but not the unemployment rate.

"They can fight deflation by printing money. They cannot directly affect employment," said Yelena Shulyatyeva, an economist for BNP Paribas in New York.

Inflation is low, but several policymakers have pushed back recently at the notion that a dangerous downward deflationary spiral is a risk.

Core inflation stood at 1.4 percent in July, according to the Fed's preferred measure, short of the 1.7 percent to 2 percent most Fed officials want to shoot for, but not by much.

Measures of inflation expectations, which policymakers also eye closely since they can influence the future path of inflation, have been on the low side but are not at levels that should trigger alarm bells.

Fed hawks see generally stable inflation expectations as a reason for the central bank to keep its powder dry.

But most Fed officials think the biggest determinant of the path of prices is the degree to which the economy is operating above or below its potential.

With the U.S. unemployment rate at an elevated 9.6 percent, some officials worry inflation could drift lower, heightening deflation risks, if the pace of the recovery does not quicken.

"The key trigger here is really on the unemployment side of the dual mandate," said Antulio Bomfim of Macroeconomic Advisers. "If they were to just do it on the basis of the inflation side, they wouldn't be there yet."

Economists think unemployment will drift higher in coming months and many see further monetary stimulus as a done deal.

Ten of 16 financial firms that deal directly with the Fed expect a new round of quantitative easing at some point, and seven of them expect it to be at the Fed's next meeting on Nov. 2-3.

© 2021 Thomson/Reuters. All rights reserved.

Even though the Federal Reserve drew a bright line under its inflation mandate at its meeting this week, officials will remain keenly focused on the strength of demand in deciding whether to ease again. The Fed edgednearer to giving the wobbling U.S. economic recovery...
Friday, 24 September 2010 01:53 PM
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