Recession-fighting efforts could lead to inflation

Published: June 24, 2009
Tags: recession, spending

Jeannine Aversa
AP Economics Writer

Washington — With signs the economy is improving but still fragile, Federal Reserve policymakers are considering whether some programs intended to drive down rates on mortgages and other consumer debt should be slowed down.

Most economists predict that Fed Chairman Ben Bernanke and his colleagues, who resumed meeting Wednesday, won’t launch any bold new efforts at the end of their two-day gathering.

Fears have grown on Wall Street that the Fed’s radical efforts to lift the country out of the longest recession since World War II could ignite inflation later on.

“Injecting additional money into the banking system is a pretty dangerous game right now, and the Fed cannot afford to press on the accelerator amid a potentially inflationary environment,” said Richard Yamarone, economist at Argus Research.

Wanting to snuff out any rise in inflation expectations, the Fed could opt to tweak its already-announced programs to slow down purchases of either government debt or mortgage-backed securities. Doing so also could help avert possible market disruptions and make it easier for the Fed to reel in these programs once the economy rebounds.

In March, the Fed launched a bold $1.2 trillion effort to drive down interest rates to try to revive lending and get Americans to spend more freely again. It said it would spend up to $300 billion to buy long-term government bonds over six months and boost its purchases of mortgage securities. So far, the Fed has bought about $177.5 billion in Treasury bonds.

The Fed is on track to buy up to $1.25 trillion worth of securities issued by Fannie Mae and Freddie Mac by the end of this year or early next year. Nearly $456 billion worth of those securities have been purchased.

But slowing down the purchases carries risk, including that rates on mortgages and government debt could rise more than expected, which could hurt the economy’s prospects for emerging from recession, economists said.

A recent run-up in rates on mortgages and Treasury securities, if prolonged, could choke off prospects for an economic recovery. Some of those fears were eased last week, when rates on 30-year mortgages dipped to 5.38 percent after a string of weekly increases.

A fresh sign of the economy’s improvement emerged Wednesday. Orders placed with factories for costly goods grew 1.8 percent for the second straight month in May, and a barometer of business investment posted its largest gain in nearly five years, the Commerce Department reported.

Meanwhile, the Fed is all but certain to hold its key bank lending rate at a record low between zero and 0.25 percent when the meeting concludes and probably through the rest of this year, economists said.

That means commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will stay around 3.25 percent, the lowest in decades.

Bernanke has predicted the recession will end later this year. Some analysts say the economy will start growing again as soon.

Even after the recession ends, the recovery is likely to be tepid, which will push unemployment higher. The nation’s unemployment rate — now at 9.4 percent — is expected climb into 2010. Some analysts say the rate could rise as high as 11 percent by the next summer before it starts to decline. The highest rate since World War II was 10.8 percent at the end of 1982.

An index measuring chief executives’ business expectations showed an improved outlook from last quarter’s record low, but many still expect declines in sales, jobs and capital spending.

“We don’t see continued free fall,” Ivan G. Seidenberg, chairman of the Business Roundtable and chief executive of Verizon Communications, said Tuesday. “But nobody’s ready to suggest they’re going to begin hiring.”

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