By Pedro Nicolaci da Costa
February 22, 2012 6:49 PM EST
(Reuters) -- U.S. central bank officials have good reason to be skeptical about the strength of the economy: excessive optimism has caught them flat-footed before.
Despite stronger employment data and hints of firmer inflation, Federal Reserve policymakers are not ruling out another round of monetary easing in the months ahead.
That's because many of them see plenty of risks that could derail the tepid pace of recovery that officials are projecting for this year and next.
A worsening of Europe's banking crisis and geopolitical tensions in the Middle East are two of the most obvious risks. But there are also domestic problems, including weak consumer demand and a job market that remains a shadow of its prerecession self.
A rapid decline in the jobless rate in recent months, to a three-year low of 8.3 percent in January from 9.1 percent in August, has surprised economists within and outside the Fed given the broader economy's relatively soft performance.
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U.S. gross domestic product grew just 1.7 percent in 2011.
"We are seeing the unemployment rate doing something very different than we are seeing in the other indicators," John Williams, the San Francisco Fed president, told reporters earlier this month.
The Fed's forecasting record hasn't been all that stellar, so it's little wonder officials are reluctant to declare victory on mere inklings of strength.
Not only did Fed officials, including now-Chairman Ben Bernanke, downplay the prospect of a housing downturn and the possibility that it could derail the economy before the financial crisis, their early forecasts for 2011 growth also proved far too rosy. At the beginning of last year, they were expecting expansion of between 3.4 percent and 3.9 percent.
One possible explanation for the disconnect is that employers slashed jobs so aggressively when the economy plunged into recession that they may have gone too far, and are now being forced to make a fresh round of new hires. At the time, economists were struck by how deeply employers were cutting relative to the drop in demand.
However, if this is the right explanation, the boost to the labor market may quickly fade, giving way to another round of stagnation in the jobless rate.
Or perhaps it's the growth readings that have been undershooting, while the decline in the jobless rate is actually telling the real story. That's a harder theory to prove -- only time will tell.
One other thesis is particularly frightening to economists. It holds that the recession has severely and permanently reduced the potential rate of growth in the U.S. economy. This would leave the Fed much less room to ease and would potentially call for tightening of policy sooner than many expect.
As things stand now, the U.S. central bank, mandated by Congress to seek both price stability and full employment, is missing badly on the jobs side, recent progress in reducing the unemployment rate notwithstanding. So why isn't it engaging in another round of monetary stimulus?
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