When the Federal Reserve began cutting interest rates in January, there was little doubt about the direction it should be going. The economy was in a steep dive. Recession seemed likely. Bold action was needed soon.
Now, six months later, the Fed is winding up its rescue effort amid a sea of uncertainty. While the economy has stopped sinking, it isn't yet clear whether it'll re-float smartly.
Recession remains a possibility. Inflation looms as a threat.
That will make the Fed's next decision on interest rates, at a meeting on June 27, one of the diciest in recent months. Not only is the central bank sailing on uncharted waters, it risks steering a course that might easily run it aground.
"The risks are substantial," said Ira Kaminow, economist at Capital Insights Group, a Washington consulting firm. "The Fed already has done a lot. It's looking to see whether it's done enough. It also wants to make sure that it's not overshooting." The prospect that the debate will be all over the lot reflects the confusion over where the economy is headed. On the one hand, businesses have worked off much of their excess stockpiles.
So far, consumer spending and housing have held up.
Beyond that, however, there's little good news. Capital investment remains weak. Profits are being squeezed. Household wealth has plummeted over the past couple of quarters, and many analysts are worried that consumer spending soon may collapse.
Just as worrisome to some economists is that inflation has begun to stage a comeback. While some price indexes are well- behaved, consumer prices are creeping up steadily, particularly for services and medical care, and labor costs are on the rise.
"While the Fed has talked a good game contending that inflation is `contained,' the numbers themselves don't look to me like that is the case," said Randell Moore, head of Blue Chip Economic Indicators, which tracks economists' forecasts.
Compounding the Fed's problems is that policy-making is at a difficult juncture. After five cuts in interest rates this year that pushed down the overnight bank lending rate by 2 1/2 percentage points, the Fed has pumped substantial stimulus into the economy.
The central bank also has been expanding the money supply.
Fed statistics show that M2 -- the most widely followed measure of money, which includes checking and savings accounts, money market mutual funds and currency held by consumers and companies -- has been growing at a 10 percent to 14 percent annual rate during much of the first half of this year. That's given the economy a boost beyond that provided by lower interest rates.
The difficulty is, with the traditional lags, policy makers won't know for several more months whether the stimulus has been sufficient to spur a recovery, or is so excessive that it risks re-igniting inflation. Right now, the answer is anyone's guess.
Complicating that analysis is the just-enacted tax cut, which will further stimulate growth. Ordinarily, Fed policy makers ought to be able to factor in the tax-cut effects. Yet, analysts are divided over what impact it may have.
"Given the lags in the whole process, there are some people who are beginning to worry that the Fed may have gone too far," said David Wyss, chief economist for S&P's, the credit-rating firm.
"If that ultimately proves to be the case," Wyss said, ``the Fed may be tempted to put on the brakes again next year if inflation starts heating up.
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