Fed reveals long term growth, inflation goals

By Alister Bull

WASHINGTON (Reuters) - Federal Reserve policy-makers on Tuesday revealed they had lowered estimates for the U.S. economy's long-term growth potential, while signaling they were aiming for inflation of 1.5 percent to 2 percent.

In the most extensive glimpse to date of recent thinking inside the U.S. central bank's interest-rate setting committee, the Fed provided a summary of policy-makers' economic projections at their meeting on October 30-31.

The Fed under Chairman Ben Bernanke has debated adopting an explicit inflation target, but concluded that now was not the right time to push the issue.

Instead, it has doubled the frequency of its economic forecasts to four times a year while broadening the scope of what it divulges, and pushing out the timeframe to three years.

"At a three-year horizon, forecasts go back to long-run trends, that means that for inflation it goes to the 'target,'" said Professor Stephen Cecchetti at Brandeis International Business School.

Fed documents showed that projections for core and headline inflation in 2010 by the 17 Fed policy-makers at the last meeting ranged from 1.5 percent to 2.0 percent. The central tendency of the estimates, which drops the top and bottom three forecasts, was 1.6 percent to 1.9 percent.

The Federal Open Market Committee comprises the seven members of the Fed Board of Governors and 12 regional Fed presidents. There are currently two unfilled vacancies at the Fed board.

"Participants' projections for PCE inflation in 2009 and 2010 were importantly influenced by their judgments about the measured rates of inflation consistent with the Federal Reserve's dual mandate to promote maximum employment and price stability," the Fed said.

In addition to headline and so-called core inflation, which strips out energy and food prices, the Fed will provide projections every quarter of real growth in gross domestic product and unemployment.

This provides rare insight into Fed thinking about the long-term pace at which the economy can grow without hitting inflationary speed bumps.

"We can now figure out what the committee's implied estimate of potential GDP growth is since at a three-year horizon, all forecasts simply return to the assumed trend. The answer is 2.5 to 2.6 percent," said Cecchetti.

The Fed said the long-term projections for real growth and unemployment were "most heavily influenced by (policymakers') views about, respectively, the economy's trend growth rate and the unemployment rate that would be consistent over time with maximum employment."

"These observations indicate that the FOMC believes that potential GDP growth is now substantially lower than early in the decade, approximately 2.5 percent annualized," wrote Bank of America Securities senior economist Peter Kretzmer.

Fed officials have for some while said that so-called new economy gains to U.S. productivity after intensive technology investment in the 1990s might have faded.

Indeed, benchmark revisions earlier this year to U.S. input and output data now suggest a "somewhat slower rate of trend growth than previously thought," the Fed said.