Vital Signs: Stronger Medicine from the Fed

On tap: December retail sales, industrial production, consumer prices and housing starts, and the Federal Reserve's Beige Book report

The economy isn't looking too healthy these days. New symptoms keep emerging: higher unemployment, weakening demand at home and abroad for factory goods, and tumbling stock prices. More evidence that the economy is getting sick could show up in the latest examination of economic data.

Economy watchers are forecasting a weak 0.1% gain in December retail sales. Figures on holiday spending already confirmed fears that this season would be the weakest in years. According to the International Council of Shopping Centers, same-store sales were up just 0.9% from a year ago.

December industrial production probably posted an outright decline. A national report on manufacturing activity from the Institute for Supply Management earlier this month already showed a decline in production and orders. A decline in factory output is a reliable indication that businesses are also feeling jittery and scaling back on investment and expansion plans. If such a defensive mentality grows stronger, it bodes poorly for hiring and wage growth.

The Federal Reserve's Beige Book, a compilation of anecdotal reports on economic activity from the regional Fed banks, will shed some light on whether once strong parts of the economy, such as the service sector, are feeling more pain.

Last autumn, the Federal Reserve was unsure how the housing recession and credit crunch would affect other parts of the economy. As a result, the Fed opted not to inoculate the economy by aggressively cutting interest rates. To be fair, the Fed was concerned at the time that slashing its target fed funds rate could spawn a very nasty side effect of faster inflation once the economy started to improve.

But inflation pressures look set to ease. December data on consumer and producer prices are expected to be quite mild compared to the energy-induced spikes in November. And inflation pressure could keep moderating. Higher unemployment should put a damper on wage growth and barring any geopolitical turmoil, weaker global economic growth will take pressure off oil prices.

When assessing the health of the economy, the Fed seems to finally feel it's time to prescribe some stronger medicine in the form of bigger interest rate cuts.