LAS VEGAS, May 28 - San Francisco Federal Reserve President Robert Parry said on Wednesday the economy is still stuck in a soft patch and the prospects are for only a modest pick-up in activity later in the year. In a signal that Parry may support further cuts in interest rates to spur the recovery, he said the Fed still has room to lower rates in spite of forecasts of stronger growth because the pace of growth will not be fast enough to use up all the spare capacity in the economy.
"At this point, it appears that the economy is still mired in the soft patch we hit last fall," Parry told a lunch organized by the Nevada Development Authority. Parry, a voting member on the Fed's policy committee this year, stressed "significant stimulus" was already in place with the Fed's 12 rate cuts over two years and the ink barely dry on the latest federal tax cut package. He said some provisions of the tax cuts would help the economy in the short term.
Parry said the combined stimulus would "hopefully mitigate the chances (of deflation)." In response to a question from the audience, he said deflation in the U.S. economy was "certainly conceivable" but that the risk was pretty small. Parry said a slow first half should give way to a "modest pick-up" in the second half of the year. That was a more somber assessment of the outlook than his forecast of "more robust growth" made in his last economic speech in late April. Other Federal Reserve officials have cited the depressing effects of the Iraq war on the recent set of weaker-than-expected economic data, but Parry reiterated his view that more fundamental economic concerns could be holding back business investment.
The Federal Reserve holds its next policy meeting in late June, and several Wall Street economists believe it will lower the benchmark federal funds rate from its current level of 1.25 percent. The latest piece of economic news on Wednesday came in below expectations, with orders for costly durable goods falling by 2.4 percent in April.
INFLATION BELOW 1 PERCENT
Parry said growth would not be strong enough to make a dent in the economy's excess capacity, so that the "true" core rate of inflation was likely to fall below 1 percent this year. He was referring to the core personal consumption expenditures index, or PCE, and was accounting for the broadly held view that the PCE probably overstates inflation by about half a percentage point. Indeed, in this year's first quarter, the core PCE rose an annualized 0.9 percent. The Fed warned in its last policy statement about the risk of deflation, a comment that has worried investors.
Parry said the outlook for lower inflation means that: "If it seemed appropriate, we still would have room to give a boost to the economy, even though it's possible the economy could pick up vigorously later in the year." He noted that even though the federal funds rate is at a four-decade low, in inflation-adjusted terms real interest rates are not so low. "Some economists would say the level of rates, as low as it is, is slightly misleading in terms of the stimulative impact because the level of real rates isn't as low as when inflation was higher," he said. In answer to a question about how policy would respond to the risk of deflation, Parry told reporters that if some external shock hit the economy and derailed forecasts for a recovery, the central bank would respond "aggressively." He also said the Fed's shift this month to identify the risks to inflation and to growth separately may be used again in the future, but it would depend on the circumstances.
"I don't think any decisions have been made that would suggest we've moved to a completely new regime. As long as we feel it makes sense to separately identify the risks to the economy that may be presented by deflation, it's possible we will have that in the statement," Parry told reporters. Asked about the dollar, he noted only that its "fairly significant" declines in recent months would probably help stimulate the economy, according to economic theory. He said the forecast for a modest pickup in growth "depends on fairly robust consumer spending," adding: "Frankly, the longer growth has to depend on the auto and housing sectors, the riskier the situation becomes." Parry said he was "a little surprised" that consumer confidence has held up as well as it has in the face of a jobless recovery, which would normally depress sentiment. Fed Chairman Alan Greenspan has said the central question in the recovery is when business investment will improve. Wednesday's durable goods report offered little hope on that front.
Economists are counting on consumer spending to hold up until business spending kicks in.//