The Fed remains worried about growth

The Federal Reserve released its first policy statement of the new year, and observers learned a few things. First, the Federal Open Market Committee remains wary about the weakness of the American economy:

Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, while investment in nonresidential structures is still weak. Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Although commodity prices have risen, longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.
I think the economic data that was coming in through December moved expectations from too pessimistic to perhaps a little too optimistic. Recent datapoints have been a little off—jobless claims have yet to hit the sub-400,000 level touched in late December, durable goods orders have softened a bit, and home prices are disappointing (though the housing figures should be treated with caution). The underlying trend in the numbers is clearly toward an accelerating recovery, but even a 4% real growth rate in 2011, which is possible, implies a long period of economic slack ahead.

Secondly, the shift in the make-up of the FOMC has not meaningfully altered the commitment to current policy, at least not yet. With the new year, perpetual dissenter Thomas Hoenig lost his voting status, but demand-side sceptics like Narayana Kocherlakota and Richard Fisher gained a vote. But the Fed's policy has not changed—the plan to purchase $600 billion in additional assets remains on track and the language on extended low rates is still in place—and indeed, the statement was supported unanimously for the first time in ages.

What remains uncertain is how this policy path will develop as the year proceeds. If commodity prices rise into the summer, will the consensus on the FOMC stand? It would be surprising if such a rise led to a big increase in core inflation given the huge slack in the labour market, but it's difficult to hold back rate increases when headline inflation jumpts to near 3%. If the unemployment rate does begin to drop meaningfully, will disputes arise over just where the new natural rate lies?

For now, the Fed's path remains easy. With unemployment too high and inflation too low, the central bank should adopt an aggressively expansionary approach. But can Ben Bernanke keep the hawks in line as recovery continues? We'll have to see.