Fed's Plosser sees lasting blow to potential growth rate

SAN DIEGO Fri Jan 4, 2013 4:33pm EST

SAN DIEGO (Reuters) - The United States economy likely suffered a lasting decline in its trend potential growth rate as a result of the severe 2007-2009 U.S. recession, a top official of the Federal Reserve said on Friday.

"Any of you who have looked at the data of the most recent ... recession, it certainly looks like we've had a permanent shock," Charles Plosser, president of the Philadelphia Federal Reserve Bank, told a panel at the annual meeting of the American Economic Association. "The problem is we won't know the answer to that for many years to come."

Fed Chairman Ben Bernanke also recently voiced the possibility that the harm done by the recession might have trimmed the United States' growth potential, which gauges how fast the economy can grow over time without hitting inflationary speed bumps.

Plosser is one of the more hawkish members of the Fed's policy-setting committee and has warned about the inflation risks posed by the U.S. central bank's current aggressive policy to spur the country's growth.

Hawks warn a decline in the rate of U.S. trend potential growth means the Fed ought be careful in trying to push the economy to grow much faster, although some economists say that the dip may only be temporary.

"If it is not permanent, it is very persistent," Plosser told reporters on the sidelines of the meeting, adding, "That has consequences for ... monetary policies' ability to do something about the shock."

The Fed last month voted to maintain mortgage-backed and Treasury bond purchases at an $85 billion monthly pace and to keep expanding its balance sheet via these quantitative easing measures until there is a substantial improvement in the outlook for the labor market.

The Labor Department on Friday reported that U.S. unemployment remained stuck at 7.8 percent in December. The Fed has committed to hold interest rates near zero until unemployment declines to 6.5 percent, provided inflation remains beneath 2.5 percent.

Plosser, who expects unemployment to drop to between 6.8 percent and 7.0 percent by end-2013, said he hoped the Fed would stop buying bonds before the 6.5 percent threshold, implying he anticipated the asset purchases would halt this year.

A danger of guessing wrong about trend growth is that it would throw off estimates about the size of the U.S. output gap, which is used to describe the amount of slack in the economy, and how much faster it can grow without sparking inflation.

The Fed's latest quarterly summary of policymakers' economic projections was for trend growth of 2.3 percent to 2.5 percent, unchanged from their estimate in September.

"One of the reasons we made the mistakes we made in the 1970s...was they mis-estimated the gap. Potential was a lot lower than they thought it was," Plosser said, referring to the period when the Fed accommodated a massive rise in inflation.

One reason that trend growth had slowed, he said, was the collapse of the housing bubble, which destroyed massive levels of U.S. wealth that families are now trying to restore by saving more, dampening their spending.

(Reporting By Alister Bull in San Diego, Calif.; Editing by Chizu Nomiyama and Leslie Adler)

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