Federal Reserve sees recession to at least mid-2009

The Federal Reserve warned that a recession believed already to be underway could last until mid-2009 or later. That's likely to mean interest rates will be cut again soon, the central bank indicated.

That, along with other economic concerns including the fate of Detroit's ailing carmakers, sent Wall Street into another panic. The Dow Jones industrial average tumbled 427 points, or 5.1%, closing below the 8,000 mark for the first time since early 2003.

The Labor Department reported that consumer prices fell a record 1% last month from September's level, bringing the inflation rate for the last 12 months to a relatively modest 3.7%. Energy prices led the way down with an 8.6% one-month decline.

On their own, lower prices are good for consumers and the overall economy.

Gary Schlossberg, senior economist for Wells Capital Management in San Francisco, said that every $1 decline in the cost of a gallon of gasoline puts $100 billion a year back in U.S. consumers' pockets. So with pump prices down more than $2 since their high in July, that would in effect be a $200-billion stimulus for the economy over the course of a year.

"If you're paying less for gasoline, you have more money left over to buy other things," Schlossberg said.

But in this case, lower costs stem in large part from a global economic contraction that has reduced demand for goods and services, causing inventories to pile up and forcing suppliers to cut prices.

Moreover, the benefit of more affordable energy is easily offset by the shrinking value of consumers' homes and stock portfolios, said Gus Faucher, chief U.S. economist with Moody's Economy.com. For every $10,000 in lost equity, he estimated, consumers spend about $500 less over two years.

"We expect to see consumer spending to be flat before inflation," translating after inflation into a rare decline, he said.

Such gloom pervaded the Fed's release Wednesday of its quarterly economic outlook, which made public the poor projections that led the agency to make two half-point reductions in its key interest rate last month.

Those attending a meeting three weeks ago of the Fed's rate-setting committee "generally expected the economy to contract moderately in the second half of 2008 and the first half of 2009," according to minutes released Wednesday.