MercoPress. South Atlantic News Agency

Fed offensive exposes cut-rates/inflation balance dilemma

United States central bank officials came out in what seems a concerted offensive to inject optimism and downplay fears of a full fledged US recession as negative data on the economy keeps piling and a discouraging factor feeling extends.

However the offensive also revealed a range of views on how much latitude the Fed has to cut rates further to thwart economic deceleration and how to reach a balance without triggering inflation. Atlanta Fed Bank President Dennis Lockhart said that recent action by the Federal Reserve is likely to calm troubled U.S. markets, but admitted inflation remains a worry. "The liquidity injections and easing of monetary policy should help housing and financial markets stabilize and avoid an 'adverse feedback loop' in which a decline in housing prices fuels financial market volatility with spillover to the broader economy". Speaking separately in Cleveland on Friday, Cleveland Fed President Sandra Pianalto acknowledged in a speech on housing that "we are going through some very difficult times right now" but did not comment on the outlook for the economy. Lockhart told the Southern Center for International Studies the Fed's sharp rate cuts in January, which took benchmark short-term U.S. rates down to 3% from 4.25% and additions of liquidity had helped address risks to growth in the U.S. economy. The Atlanta Fed chief said inflation has been higher than his personal comfort zone, but should moderate in the second half of the year. Dallas Fed President Richard Fisher said on Thursday the Fed must be careful with any rate cut tonic it applies because of the danger of igniting inflation from already high levels. Richmond Fed President Jeffrey Lacker and Philadelphia Fed President Charles Plosser echoed concerns about high inflation. "We can't cut interest rates as aggressively in response to weakness in growth as we otherwise would" Lacker said on Thursday. And San Francisco Fed President Janet Yellen late on Thursday indicated a willingness to cut rates further, adding she is not confident a recession can be avoided this year. Lockhart warned inflation undermines economic growth and stressed the Fed has to focus on price stability, but as the economy softens, inflation is likely to ease. "I would never say inflation is a good thing," he said in answering questions. "I think it's clear that the zone or the range of inflation that some of my colleagues feel is most comfortable, is safe, (is) between 1.5 and 2%, perhaps slightly higher, depending on how you measure," he said, adding that in the current economic environment, the Fed's latest rate cuts were appropriate. "I felt comfortable supporting recent policy actions to lower rates because at that particular time it was appropriate to view the general economy as a priority," he said. "We are always running a risk, it's a very, very well-informed judgment but that is the trade-off as I saw it." Lockhart described the recent deceleration of economic growth as "sharp" and noted that some analysts have seen a possibility of recession. However, he said his own outlook is for weakness in the first six months of 2008, followed by improvement in the final half of the year. Janet Yellen, answering questions from the audience after a speech in Honolulu on the economic outlook said the Fed's top priority right now is guarding against "extreme downside risks" to the U.S. economy. But she also warned that removing the current level of monetary incentives will be crucial to preventing the emergence of new asset bubbles. Yellen said it was vital crucial that the Fed avoids an inflation spiral such as the one that occurred in the 1970s. "An extended spell of slow growth was the most likely outcome of the current mortgage and financial situation" but Yellen also admitted that a recession was within the range of normal forecasting error. A recession is considered when two consecutive quarters downturn. Recent economic data suggests the U.S. labor market is contracting in a way harmful to consumer spending, but "we don't yet have a dramatic deterioration". The Fed's policy-setting committee is not due to meet again until March 18, and financial markets anticipate another rate cut of between a half-percentage point and three-quarters of a point. Fisher, Plosser, and Pianalto are voters on the Federal Open Market Committee, while Lockhart and Yellen are not.