But then there is inflation.
Interviews with Fed officials and those familiar with its thinking
show the mood inside is more somber than the central bank's
reassuring statements and evidence of robust economic health would
suggest. The reason is the central bank's failure to nudge price
growth up to its 2 percent target and, more importantly, signs that
investors and consumers are losing faith it can get there any time
Despite undershooting the goal for three years, the Fed has long
succeeded in convincing markets that the target was within reach.
However, inflation expectations have begun slipping in recent weeks,
threatening to amplify downward momentum from plunging energy prices
and stuttering global growth.
Barring a turnaround, Fed officials would hesitate to raise interest
rates as soon as mid-2015 even as gradually as their forecasts now
suggest. On Friday, prices of short-term interest rate futures
showed traders pushed back their expectations for a "lift-off" in
rates from near zero until October 2015, later than most Fed
officials have signaled so far.
"The primary concern at the moment is whether you can get back to 2
percent in a way that keeps expectations anchored, and maintains the
credibility of the Fed as an institution that can achieve its goal,"
said Jeffrey Fuhrer, the Boston Fed's senior policy advisor.
At first sight, a combination of economic growth of nearly 4
percent, falling unemployment and price increases of around 1.6
percent looks good. Central bankers worry, though, that inflation,
instead of picking up further, could head the other way.
RESISTING THE URGE
For the Fed, 2 percent inflation provides a necessary buffer against
deflation, and sufficient leeway to leave crisis era "zero lower
bound" on interest rates behind and start using them as the main
policy lever again.
"We're below the Fed's 2-percent target now, but what if we get to 1
percent? And then 0.5? You need to cut that off," said former Fed
Vice Chairman Alan Blinder, who teaches at Princeton University.
One Fed official, who declined to be named, told Reuters
policymakers must resist the urge to lift rates at the first
opportunity because they might be forced to backtrack if inflation
failed to pick up.
Narayana Kocherlakota, who has been a dissenting voice and voted
against ending the Fed's bond buying program in October, says time
is ripe for the Fed to come clean on inflation and act.
"A key for us would be to be communicating effectively and then
taking actions to live up to that communication that we are trying
to get inflation back to 2 percent as rapidly as possible," the
Minneapolis Fed president said last in November.
Other officials, who declined to be named, were not ready to sound
alarm yet but said that if inflation continued to disappoint the Fed
would have to admit it did not know how long it could last, or how
it might shape longer-term expectations.
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They also flagged a growing concern that oil prices, which hit a
four-year low below $70 a barrel on Friday, will depress the "core"
price measures the Fed uses to steer its policy.
For now, however, most policymakers opt to stick with the
tried-and-tested theory that monetary stimulus and accelerating
growth will eventually lift inflation and fear that airing their
doubts could make the Fed's target even harder to accomplish.
Reflecting such fears, the Fed's Oct. 29 policy statement left out
references to recent market turmoil and economic weakness in Europe,
Japan and China, while downplaying a drop in market-based inflation
The meeting's minutes, released later, showed policymakers raised
those concerns but decided not to air them to avoid undermining
investors' confidence in the U.S. recovery.
"I think deep down they are worried about un-anchoring inflation
expectations," said Vincent Reinhart, chief U.S. economist for
Morgan Stanley. Reinhart, who led the Fed's monetary affairs
division in the early 2000s, described recent Fed statements as
"tone deaf" on downward price pressures.
Primary dealers surveyed by the Fed still expect inflation to reach
2 percent by 2016, roughly matching central bankers' forecasts.
Other measures, however, have slipped.
Prices of inflation-protected bonds show inflation expectations near
three-year lows and a survey by the University of Michigan showed
consumer expectations hit the lowest level since 1992.
Furthermore, economists surveyed by the Philadelphia Fed now see
inflation averaging below 2 percent at least until 2017 whereas only
three months ago they expected the Fed to hit its target by the
first quarter of 2015.
William Dudley, the influential New York Fed president, hinted at
the possible response to a further cooling in prices, saying last
month the central bank could run the economy "hot," keeping rates
low longer than what growth and jobs data would have suggested.
(Reporting by Jonathan Spicer and Ann Saphir; Editing by Tomasz
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