Fed: Economy continues to recover despite setbacks; inflation under control

Federal Reserve officials shrugged off recent spikes in inflation and a slowing of the economy at their April meeting, maintaining the outlook that the economy was steadily improving and long-term inflation was under control.

Fed officials also continued to hold a united front on the Fed’s second round of quantitative easing, dubbed QE2. However, minutes of the April meeting of the Federal Open Market Committee (FOMC) released Wednesday indicate the end is in sight for that initiative, as officials discussed how to unwind from it in the future.

{mosads}Although weak spending data drove Fed officials to slightly downgrade their economic outlook for the first half of the year, the minutes show that they largely believed the downturn to be driven by extraordinary events, like the disaster in Japan.

As a result, the immediate outlook may be dampened, but Fed officials still have the same expectations for economic growth in 2012 and 2013. They expect the economy will grow at a rate that can gradually bring down unemployment, even as the jobless rate is expected to remain elevated at the end of 2012.

Staying true to previous Fed findings, officials reported generally positive information about the economic recovery as it steadily grew from the depths of the recession. The housing market continues to be “very weak,” as the glut of foreclosed properties discourages new construction and drives down home prices, but business contacts are generally optimistic.

Recent consumer price data drove the FOMC members to revise upwards consumer price inflation in the near term. The Fed has had to fend off accusations that its accommodative monetary policy — including the $600 billion of Treasury bonds it is buying in an attempt to lower rates — is driving out-of-control inflation. However, despite the recent spike in prices, members of the FOMC maintained that underlying inflation was still “subdued,” and that inflation expectations over the long term are still stable.

It was evident from the minutes that Fed officials are preparing to wind down that extremely accommodative policy, as they detail a lengthy discussion about how exactly the Fed should unwind those large amounts of bond purchases and begin boosting interest rates again.

Although the minutes note that discussing the strategy for tightening monetary policy is not necessarily an indication such steps would begin soon, FOMC members discussed a number of ways for the central bank to return to a more typical monetary policy stance.

When it decides to tighten policy, Fed officials said they had two tools to work with — raising interest rates, and selling the assets it has accumulated during quantitative easing and other financial relief efforts. The Fed can tighten policy by raising rates, selling assets or some combination of the two, officials said.

“They could be combined in various ways to achieve similar outcomes,” the minutes state. “For example, in principle, the Committee could accomplish essentially the same degree of monetary tightening by selling assets sooner and faster but raising the target for the federal funds rate later and more slowly, or by selling assets later and more slowly but increasing the federal funds rate target sooner and faster.”

However, FOMC officials also grappled with how they should approach the use of those two tools. They identified two conflicting agendas: On the one hand, the Fed could vary how quickly it unloads the assets in response to economic and financial conditions, which would grant it added flexibility. On the other, if the Fed decided to sell off the assets at a regular pace, relying instead on setting interest rates as the primary means of guiding economic activity, it would result in a policy that is more consistent and easier for the Fed to explain to the public.