Fed’s No. 2 Man Is Cautiously Optimistic

The nation’s stumbling economic recovery is gradually picking up speed, but it is not on firm ground yet, the No. 2 man at the Federal Reserve says.

“We are in a very modest, moderate growth phase of between 2 and 3%,” Vice Chairman David Mullins said. But “we still have some downside risks.”

That’s not great news for President Bush, who is counting on a stronger recovery to help win a second term in November.

Mullins said the next few weeks will be crucial in determining the durability of the modest recovery and assessing the central bank’s interest rate policy.

“We’re going to watch it (the economy) very carefully,” Mullins said.

Analysts said the comments suggest that the Fed stands ready to cut interest rates again if the economy shows signs of faltering. That belief helped pressure Treasury bill yields Monday.

The Bush Administration last year blamed the Fed for choking off a tentative recovery by failing to ease credit in the face of slowing growth in the money supply. Deputy Treasury Secretary John Robson said that remains a concern.

“We want to make sure that the money supply is kept at an adequate level so that recovery is sustained and nourished,” Robson said.

But Robson said he does not “have any apprehension that we are going to slip back into some kind of recession.”

Mullins also expressed cautious confidence. The Fed vice chairman said that, on the whole, he has been encouraged by recent economic data.

“There is evidence this recovery is consolidating and spreading out,” he said.

Factory orders are growing, inventories are low and consumer confidence is continuing to rise, albeit slowly, he said.

Even the job market is showing signs of firming, although Mullins does not expect unemployment to decline much until growth climbs above 3% later this year.

“I think it will probably be the third quarter before we can knock some real numbers off of unemployment,” he said.

Slower inflation is also on the horizon.

“We have good fundamentals in place” to bring down inflation, Mullins said, citing the slow money growth of recent years and restrained commodity prices. “I don’t feel there’s evidence we’re over-stimulating or going too far.”

He blamed the recent rise in long-term interest rates not on concern about inflation but on worries about the federal government’s big structural budget deficit.

But despite the growing signs of better times, he said it is too soon to say that a satisfactory recovery is assured.

“We’re moving toward that,” Mullins said. “But I’m not quite prepared to say we’ve reached that stage.”

He cited several reasons for his caution.

Consumers and companies are still burdened with debt, although they have made progress in whittling that down. Mortgage rates have risen, threatening to take some of the steam out of the housing market. And corporate purchasing managers turned more cautious in April, although their latest survey was still consistent with growth of 2% to 3%.

“The real question is whether we go up to sustainable growth in the 3 to 3.5% range . . . or whether we fall back down to something like we’ve had for the past three years,” Mullins said.

“That’s something to look out for.”