FED STUMBLES UPON A NEW PROBLEM / THE WALL STREET JOURNAL

Heard on the Street

Fed Stumbles Upon a New Problem

By Justin Lahart

Dec. 23, 2014 3:31 p.m. ET

 

Last week, Federal Reserve policy makers offered up their final projections on what the economy would end up looking like in 2014. The fact that there were only two weeks left in the year didn’t stop those forecasts from being wrong, underscoring how tricky the interest-rate terrain will be for investors next year.

The Commerce Department on Tuesday said gross domestic product expanded at a 5% annual rate in the third quarter, faster than its earlier estimate of 3.9%, on upward revisions to consumer and business spending. That, and a separate Commerce Department report showing that consumers ratcheted up spending last month, had economists raising forecasts for the current quarter.

Macroeconomic Advisers now sees GDP expanding at a 2.8% pace in the fourth quarter. This would translate into 2.6% growth for the full year, based on the change from the fourth quarter a year earlier. The Fed’s projections call for full-year growth of just 2.3% to 2.4%.

The Commerce Department also reported that its gauge of consumer prices fell 0.2%, pressured by falling gasoline costs. Prices excluding food and energy, the core measure the Fed watches closest, were flat, putting them up just 1.4% from a year earlier. That contrasts with Fed projections for core prices to rise 1.5% to 1.6% in the fourth quarter from a year ago.

The Fed’s forecasts for next year could be wrong as well, and wrong in the same direction.

Fed policy makers’ projections are centered on an expectation that GDP will expand 2.8% in the fourth quarter next year from this year’s fourth quarter, or just a smidgen faster than this year. Yet lower gasoline prices are providing a powerful boost to consumer spending that will carry over into next year. At the same time, the healthier job market is providing people with further impetus to spend more and the means to do it. So faster growth may be in the cards.

Meanwhile, the drop in energy prices will to some extent filter into prices for other items, and that will help cool inflation. So, too, will the lower import prices that are coming via the dollar’s strength. Fed policy makers’ forecast for core prices to increase 1.5% to 1.8%, while still low, risks not being low enough.

But if the Fed’s projections are wrong, what will it do about it? It wants to get around to “normalizing” rates—that is, raising them toward the 3.75% it thinks are right for a fully functioning U.S. economy—and faster growth should give it cover to do that. So long as low inflation persists, though, it will be hard to do so quickly, if at all.

This counts as a good problem for the Fed. But it still counts as a problem, one that both it and investors will have to figure out.