Central bankers may be worried about the U.S. recovery's slowing pace, but inflation is also on their minds

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Starting Tuesday, the Federal Reserve's monetary policy committee will hold its only meeting between May and July. Since its last meeting in late April, analysts have come to realize that the U.S. economy has hit a bump. In the meantime, the Fed's latest round of monetary stimulus is set to end at the end of this month. Does this formula add up to an exciting meeting or another snore?

More Stimulus? Don't Bet On It

The big question is whether or not the Fed economists will consider trying to stimulate the slowing economy by more asset purchases. The timing here is key. As the economy has begun to slow, the Fed would end its current stimulus measure after this month.

Cheerleaders of additional Fed intervention probably won't be happy with this week's meeting, however. Earlier this month in a speech on his U.S. outlook, Chairman Ben Bernanke indicated that he believes the current troubles facing the U.S. economy are transitory. He spent the lion's share of his speech worrying about inflation, which further indicates that the Fed might not think that additional stimulus would be prudent right now.

Staying the Course

Instead, expect to see the Fed remaining on the path it set out on earlier this year. It'll end the asset purchases this month, as planned. But the central bank will continue to reinvest maturing securities, to keep its balance sheet stable, not contracting. We'll hear of no additional action being taken, despite what will likely be a more somber economic outlook than the economists provided in April.

Of course, the Fed will also leave interest rates very low. In fact, it's very likely that the committee will maintain its language indicating that rates will be low for "an extended period." Changing that language would spook the market. Investors would see the move as an indication that the Fed is preparing to raise interest rates in the near- to medium-term. As long as the Fed's language remains unchanged, the market can safely assume that interest rates will be stable at a very low rate for a long time.

Discussion of an Inflation Target?

If there's any opportunity for a surprise out of the Fed meeting, it could come from mention of a discussion about adopting an inflation rate target. Last week, reports indicated that Fed officials have begun considering naming a specific range for inflation, instead of just adhere to its mandate to keep prices stable.

Setting a clear inflation target could help the Fed to better control inflation expectations, as it would leave less about price trends up to the market's interpretation. The downside, however, is that a specific target would also limit the Fed's flexibility to expand or to shrink the money supply in the short-term to attain its other mandate -- full employment. Aggressive measures to fight economic distress could cause inflation to drift out of the Fed's target range over the short-term.

If the Fed economists really are considering an inflation target, we probably won't learn about their discussion this week, however. Donald Kohn, retired vice chairman of the Board of Governors and 40-year Fed veteran, says that such a change wouldn't occur suddenly. Instead, it would take a great deal of public discussion and probably some consultation with Congress.

If an inflation target is discussed, what is said probably won't make it into the Fed's short, to-the-point post-meeting statement. Instead, the minutes could contain some mention of such a discussion. Of course, it is also possible that Bernanke could address the question in his post-meeting press conference. So look for that, as reporters would be crazy not to pose this question to the Chairman.

Image Credit: REUTERS/Jason Reed

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