Economy fragile, Hub Fed chief says

Eric Rosengren, speaking yesterday to the Greater Boston Chamber of Commerce, said the Federal Reserve and US government risk undermining a fragile recovery if they move too soon to raise interest rates, eliminate Fed lending programs, cut federal spending, or raise taxes to reduce the federal deficit. After suffering a severe banking crisis and recession in the 1990s, for example, the Japanese government raised taxes to reduce deficits as soon as the first signs of a recovery appeared, Rosengren said. The result was another recession and an extended period of economic stagnation.

“It is important that monetary and fiscal policy continue to support the economy until private sector spending has resumed, and until we are confident that the recovery will continue once the programs that have supported the economy over the past year are removed,’’ Rosengren said. “We need to be sure the economy continues on a path that will bring the unemployment rate down.’’

The Labor Department reported yesterday that the national unemployment rate rose to its highest level since June 1983, increasing to 9.8 percent last month from 9.7 percent in August. Job losses accelerated to 263,000 from 201,000 in August, disappointing investors who expected a recent trend of diminishing job losses to continue.

The Dow Jones industrial average fell 21.61 to 9,487.67, and Standard and Poor’s 500 Index lost 4.64 to close at 1,025.21. The technology-heavy Nasdaq Composite fell 9.37 to 2,048.11.

Rosengren, speaking at the Four Seasons Hotel in Boston, said the economy has begun to recover, but the expansion will be weak, resulting in high unemployment rates for the next couple of years.

“Economies that have suffered significant financial problems come out of recessions very slowly,’’ he said. The unanswered question, he added, remains, “Are firms and households going to be ready to spend as the government programs subside?’’

Following last year’s financial crisis, the Fed slashed its benchmark interest rate to near zero and pumped more than $1 trillion into the economy through various programs, including the purchase of government and mortgage-backed securities. The federal government, meanwhile, is running up $1 trillion-plus deficits to cover the costs of financial bailout and stimulus spending programs.

Many economists have raised concerns that these policies could spark an inflationary cycle if they are kept in place too long. The danger comes if demand starts to grow too quickly and rapidly drives up prices. Rosengren, however, said falling prices remain a greater risk than rising ones. The concern is that extended weakness in the economy will undermine demand and lead to destructive cycle of deflation.

In that cycle, demand for goods declines, so businesses slash prices to attract buyers, who stay on the sidelines waiting for prices to fall further. Inventories build, businesses cut production, and more workers lose jobs. Consumers cut spending more, and the cycle repeats.

Inflation as measured by the Fed’s preferred benchmark, the core personal consumption expenditure index, is running at 1.3 percent a year, well below policy makers’ comfort zone of about 2 percent, Rosengren said. Meanwhile, lending has improved, but has not returned to normal. Falling commercial real estate prices and rising loan delinquencies pose new problems for banks. Rising unemployment is cutting incomes and holding down wages. Households have yet to recover from stock market and housing crashes, further restraining consumer spending.

These conditions suggest that policy makers should maintain stimulative policies to support demand until the recovery gains traction, Rosengren said.

“Despite the many positive signs, we are seeing in the economy, the financial markets and the real economy need more time to heal,’’ Rosengren said. “In particular, we need the economy to grow rapidly enough that unemployment falls substantially and inflation settles at a rate near 2 percent.’’

Robert Gavin can be reached at rgavin@globe.com.