De­fla­tion con­cerns gain new ad­vo­cate

Paper by chief of St. Louis Fed warns of ‘Ja­pan-style out­come’ if key rate isn’t in­creased soon

Austin American-Statesman - - BUSINESS -

In an un­usual move that un­der­scored an in­ten­si­fy­ing de­bate at the Fed­eral Re­serve, the pres­i­dent of the St. Louis Fed re­leased a paper Thurs­day warn­ing that the cen­tral bank’s pol­icy of keep­ing in­ter­est rates near zero dur­ing the eco­nomic cri­sis could lead to de­fla­tion as se­vere as that fac­ing Ja­pan.

In de­fla­tion, as­set prices fall, and a down­ward spi­ral takes hold, where busi­nesses and con­sumers hoard cash on the as­sump­tion that prices will be lower soon. That leads to a stall in eco­nomic growth, or con­trac­tion, and jobs and in­come are lost in a down­ward spi­ral. Ja­pan has long been mired in such a slump; Amer­ica’s last se­ri­ous case of de­fla­tion was dur­ing the Great De­pres­sion in the 1930s.

The pres­i­dent of the St. Louis Fed, James Bullard, warned that with­out more ag­gres­sive moves to spark its own slow­ing econ­omy, the U.S. could be in for sim­i­lar de­bil­i­tat­ing de­fla­tion. The Fed has kept its bench­mark in­ter­est rate at a record low be­tween zero and 0.25 per­cent since De­cem­ber 2008.

“Promis­ing to re­main at zero for a long time is a dou­ble-edged sword,” he warned, say­ing

that the Fed’s ef­fort to stim­u­late the econ­omy that way may have the un­in­tended con­se­quence of an­chor­ing ex­pec­ta­tions for fall­ing prices. “The U.S. is closer to a Ja­panese-style out­come to­day than at any time in re­cent his­tory.”

For now, Bullard thinks the de­fla­tion risk is still low, but his paper am­pli­fies con­cerns about the pos­si­bil­ity — as well as the un­ease in­side the cen­tral bank over tak­ing new steps to stim­u­late growth. Kansas City Fed Pres­i­dent Thomas Hoenig has con­sis­tently voiced his con­cerns about de­fla­tion at the Fed board’s monthly meet­ings this year.

Fed Chair­man Ben Ber­nanke and his col­leagues are due to meet next on Aug. 10. Econ­o­mists don’t think the Fed will an­nounce new pol­icy ac­tions at that time un­less the econ­omy se­ri­ously de­te­ri­o­rates be­fore then.

Ber­nanke told law­mak­ers on Capi­tol Hill last week that the Fed pol­i­cy­mak­ers had sev­eral op­tions if the econ­omy wors­ens. They could cut to zero the in­ter­est rate paid to banks on money parked at the Fed. They could also pro­vide more in­for­ma­tion about how long it will keep in­ter­est rates at record lows. Ber­nanke also left the door open to restart­ing pro­grams to buy mort­gage se­cu­ri­ties or govern­ment debt, the lat­ter which Bullard says should be con­sid­ered.

A bet­ter way to stim­u­late eco­nomic growth now, Bullard ar­gued, is to have the Fed ag­gres­sively buy up govern­ment debt. The Fed tried this at the start of the cri­sis, with some suc­cess. Dur­ing a pe­riod of late 2008 and early 2009, the Fed pur­chased se­cu­ri­ties backed by U.S. mort­gages, auto loans and other debt, in­clud­ing up to $300 bil­lion in U.S. Trea­sury se­cu­ri­ties. The re­sult was lower in­ter­est rates for busi­nesses and con­sumers, es­pe­cially home­own­ers, and greater eco­nomic ac­tiv­ity.

The Fed’s bal­ance sheet also swelled to an un­prece­dented $2.3 tril­lion, rais­ing con­cerns about how the Fed could pay off those debts and that it might end up mon­e­tiz­ing the debt and ef­fec­tively de­valu­ing the cur­rency.

“It pays to think ahead about things that might hap­pen,” Bullard told re­porters. “This is a mat­ter of be­ing ready, in case some­thing else hits.”

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