Recession Over, but Fed Still Worried

By Dr Lynn Reaser

The National Bureau of Economic Research (NBER) made it official last week:  The “great recession” ended in June 2009, lasing for 1-1/2 years.  A day after the NBER’s declaration, Federal Reserve Policy officials convened for their regularly scheduled meeting.  They concluded the session voicing concerns about the pace of the economic recovery and, more importantly, about the trend of prices.

The Fed operates under a dual mandate:  Under law, Congress has dictated that it strive for maximum employment consistent with price stability.  Monetary policymakers have recently interpreted price stability as corresponding to an increase in consumer prices, excluding food and energy, of around 1.5% to 2.0%.  During the past three months, this measure of “underlying price trends” has been increasing at an annualized rate of just 1.0%.

While the probability of falling wages and prices in the U.S. would appear to be low, deflation’s effects could be pernicious.  Falling prices would increase the burden of debt servicing costs, while causing consumers and businesses to defer purchases on the expectation of lower prices in the future.  Japan’s “lost decade” and its ongoing stagnation point to the damage of deflation and deflationary expectations.

The Fed has indicated that it could launch a new round of “quantitative easing” in which it would revive purchases of U.S. Treasury securities in an effort to reflate the economy.  It is unknown what pace of asset purchases would be necessary to “reflate” the economy but it could be massive.

While further efforts of monetary stimulus could be helpful to ward off deflation, caution should be exercised.  It will be necessary to eventually wind down the Fed’s balance sheet that has already ballooned to $2.3 trillion.  Gold’s rise to a record of around $1,300 an ounce suggests some of the inflation risks that might loom for the future.


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