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Prices pose dilemma for Fed

Its priority is prodding expansion, but in a surprise, inflation accelerated in January.

February 21, 2008|Peter G. Gosselin | Times Staff Writer

WASHINGTON — An ominous scenario of rising prices and slowing growth showed itself in spades Wednesday as the government reported that consumer prices are rising at a fast pace even as the housing sector remains stuck in its worst slump in a quarter-century.

The combination of inflation and faltering growth -- the infamous "stagflation" of the 1970s -- creates a potential double bind for economic policymakers: Fight one and risk feeding the other.

To the amazement of many analysts, however, the Federal Reserve, under Chairman Ben S. Bernanke, signaled that it had already decided how it would address that dilemma. The plan is to tackle the slowdown through continued interest rate cuts while accepting the risk of higher prices.

In the minutes of its late-January meetings and several conference calls released Wednesday, central bank officials made it clear that they would go for growth.

"In 2007, they were balancing their two objectives of price stability and sustainable economic growth," said Vincent Reinhart, former director of the Fed's division of monetary affairs. But now, "they care about growth first. They're going to take a chance with inflation, and if you look at their projections, they think they can get away with it."

The danger is that prices will get out of hand as they did in the 1970s and as they hinted at doing again in the report of January inflation.

The 0.4% increase in the overall consumer price index reported for last month was higher than analysts had expected. But in the latest report, it was striking that the increases were not limited to the usual suspects, food and energy. Instead, they also involved categories that had fallen or remained stable previously -- and thus had helped offset the recurrent food and energy increases.

Computer prices, for example, which had tumbled 12% over the last year, climbed 1% last month, according to Stephen G. Cecchetti, former research director of the New York Federal Reserve Bank. And restaurant meals, which had been stable, rose at a 4.9% annual rate, he said.

In January, "you have to look with a microscope to find falling prices. At the level of detail normally reported . . . more than three-quarters of prices rose," said Cecchetti, now an economist with Brandeis University.

The price index's 12-month change through January was 4.3%. By contrast, the index's annualized rate of change stayed mostly between 2% and 3.5% from 2002 through 2006 -- even as the economy picked up speed.

The biggest increase in the January inflation report was fuel (up at a 54.7% annual rate during the month), and oil prices have continued to climb, reaching a record $100 a barrel this week.

"I think oil has a shot at hitting $150 a barrel before the end of the year," said Peter Schiff, chief executive of Euro Pacific Capital, a Connecticut brokerage house. "This is a highly inflationary period, and we're creating the inflation."

Over the last month, Fed leaders have repeatedly signaled that their long-standing concern about inflation was giving way to worry about growth, housing and frozen credit markets. In January, the Fed's policymaking Federal Open Market Committee made some of the steepest interest rate cuts in its history.

But until Wednesday, the Fed had not come right out and said it thought rates would have to be held "relatively low" for an extended period, as the newly released minutes do. Nor had it acknowledged that the low rates would mean higher inflation, as the forecasts included in the minutes effectively do.

"Several participants noted that the risks of a downturn in the economy were significant," said the minutes of the Fed's conference calls Jan. 9 and Jan. 21 and the Jan. 29-30 meeting. "Many participants were concerned that the drop in equity prices, coupled with the ongoing decline in house prices, implied reductions in household wealth that would likely damp consumer spending."

According to the minutes, some members of the committee said that when the economy had improved, "a reversal of a portion of the recent easing actions, possibly even a rapid reversal might be appropriate."

Still, policymakers suggested that their interest rate cuts are not feeding inflation because the economy is so weak there's no pressure to push up prices. Their position was hard to square with the latest report, showing an accelerating CPI.

The depth of the economic quandary and the risk confronting Fed policymakers as they pursue their strategy are clearest when contrasted with the approach of other central banks around the globe. Most put a single goal above all others -- price stability.

"The Fed is inverting that," Reinhart said. "They're putting growth first."

Although the mood of the Fed's January meetings was far from alarmist, a revised economic forecast included in the minutes noted that growth would be lower, and inflation and unemployment higher, than policymakers had predicted as recently as October.

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