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Dark clouds in the Fed's silver lining

Fed officials, confident GDP will pick up, are also admitting that the job market may not.

Mark Gongloff, CNN/Money Staff Writer

July 23, 2003: 5:48 PM EDT

But look closely, and you'll see there are some dark linings to those silver clouds: namely, that job growth won't pick up for quite some time, and that prices will stay dangerously low -- no matter how strong economic growth is in the next several months.

Fed Chairman Alan Greenspan and Dallas Fed President Robert McTeer, in recent speeches and public comments, have echoed the belief, now widespread among economists and investors alike, that growth will pick up substantially in the second half of the year, fueled by tax cuts, low interest rates, a weaker dollar and other factors.

"I think all the stars are aligned for the economy to pick up," McTeer told CNNfn Tuesday. "It's been growing; it just hasn't been growing fast enough to create new jobs. But I think the tax package, on top of easy money, will probably kick it over."

But McTeer admitted his outlook was based on little more than "a hunch and a hope," and he admitted that excessive optimism has been the hallmark of recent years.

Then Fed Governor Ben Bernanke said Wednesday that gross domestic product (GDP), the broadest measure of the nation's economy, could grow at a 3 percent rate the rest of this year and a 4 percent rate next year, but he added that the unemployment rate would still be as high as 6 percent by the end of 2004.

What's more, Bernanke said stronger GDP growth would do nothing to stop a recent slide in inflation that's alarmed many economists. The worry: that the economy could get hit by deflation, an unstoppable drop in prices that has hounded Japan's economy for much of the past decade.

"Even if the economy recovers smartly for the rest of this year and the next, the ongoing slack in the economy may still lead to continuing disinflation," Bernanke said.

GDP grew at a paltry 1.4 percent rate in the fourth quarter of last year and the first quarter of this year, and probably wasn't much stronger in the recently ended second quarter. Meanwhile, the unemployment rate has risen to 6.4 percent, the highest rate since April 1994.

And two measures of core consumer inflation -- the Labor Department's consumer price index (CPI) and the Commerce Department's personal consumption expenditure (PCE) index -- have fallen steadily in recent years.

Core CPI has fallen from 2.3 percent in June 2002 to 1.5 percent in last month, and the core PCE index has fallen from 1.7 percent in May 2002 to 1.2 percent in May 2003, the latest data available.

Falling prices are usually a wonderful thing, and most economists doubt the current levels of inflation are worth losing any sleep over.

But there could be dangerous consequences if inflation continues to fall, especially if it turns into deflation. Deflation can crush corporate profits and hurt wages, hobbling the overall economy.

Bernanke said that, even if the economy grows as strongly in 2003 and 2004 as most economists expect, the PCE index, the Fed's favorite inflation measure, would continue to fall to about 0.7 percent -- dangerously close to zero, at which point the prospect of deflation would be much more realistic.

Dallas Fed President McTeer, after a speech of his own Wednesday, said GDP could grow as fast as 5 percent a year for two years without sparking inflation. GDP hasn't grown at 5 percent for two years in a row since 1972-73.