What to do about an economy stuck ‘between fire and ice’?

No, thanks, she'll walk: a sign of the times in Oakland, Calif.
REUTERS/Robert Galbraith
No, thanks, she’ll walk: a sign of the times in Oakland, Calif.

With a new poll showing rising pessimism over the economy — 82 percent said it is doing badly — and unemployment, oil prices and food costs on the rise, the U.S. Federal Reserve found itself Wednesday between a rock and a hard place (or as one economist put it, “between fire and ice”) and decided to stay put on interest rates, for now.

According to the Los Angeles Times, “The economic pessimism has deepened sharply in the last year, intensified by higher fuel prices, the poll found.” The Times said this mood “is reflected in an all-time low in [President] Bush’s approval rating — just 23% now, compared with 34% in February.”

The poll, commissioned by the Los Angeles Times and Bloomberg, found that most Americans are feeling pinched.

“Seven in 10 of those surveyed say higher gas prices have caused them ‘financial hardship,’ reported Rich Miller of Bloomberg.com. “More than 1 in 3 respondents say they have cut back on their spending over the last six months as oil and food prices surged and unemployment rose.

“That’s bad news for the economy,” he added. “With consumers accounting for 70 percent of gross domestic product, any pullback in their spending would have an outsized impact on the economy. In a note to clients this week, Deutsche Bank AG economists estimate that U.S. annual growth may be cut by a half to a full percentage point if consumers spend less and save more.”

Upside, downside and sideways
The Fed took no action on rates Wednesday; in a statement it said, “Although downside risks to growth remain, they appear to have diminished somewhat, and the upside risks to inflation and inflation expectations have increased.”
 
“The Federal Reserve stood pat on interest rates Wednesday, but it was hardly out of complacency,” the Wall Street Journal said.

“Caught between heightened inflation fears and persistent concerns about a sluggish economy, Ben Bernanke and his fellow policy makers decided to leave the Fed’s key short-term interest rate unchanged at 2%. The non-move marked the end of a series of rate cuts dating back to last summer, when credit woes were creeping up on the economy.”
 
Indeed, “The bank is in a bit of a pickle,” the Journal said.

“Fed officials are trying to avoid rate increases for now to avoid exacerbating the weakness in employment, financial markets and the housing sector. At the same time, they are trying to signal they’re serious about fighting inflation by talking about the risks of rising inflation expectations and suggesting a willingness to act quickly if inflation expectations get out of hand.”
 
According to CNNMoney.com, “Some Fed watchers said the Fed had no choice but to talk tougher about inflation.

” ‘The Fed is talking hawkish because it’s all they can do,’ said Rich Yamarone, director of economic research at Argus Research. ‘It can’t cut rates due to the rising inflation environment and it can’t raise rates due to the frailty of the economy and financial markets.’ ”

It added that “most economists are expecting the Fed to stay on hold until at least the end of the year, if not into 2009. And some economists say it’s possible the Fed’s next move might still be to cut rates further, not raise rates.”

Other economists “say the Fed is caught between hoping for inflation pressures to retreat and hoping for the economy to show some improvement, despite recent reports on consumer confidence, jobs and the housing market showing further weakness,” CNNMoney reported, quoting Bob Brusca of FAO Economics: “The Fed seems to be focused on a strengthening economy. But assuming does not make it so. Inflation risks will diminish only when you hike rates.”

However, according to the BBC, “some economists say that raising rates could worsen the economic slowdown caused by crises in the credit and housing markets. … It is a situation that the head of the International Monetary Fund, Dominique Strauss-Kahn, recently described as being caught between ‘fire and ice.’ ”

Given that — and all the guessing going on — we’ll give the last word to David Kelly, economist and chief market strategist for JPMorgan Funds, who told CNNMoney:

“I don’t think there’s anything preordained because I don’t believe they know what their next move will be.”

Susan Albright, a MinnPost managing editor, writes about national and foreign developments. She can be reached at salbright [at] minnpost [dot] com.

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