Fed's Bullard raises specter of Japanese-style deflation
By Neil Irwin
A top Federal Reserve official has published an important new paper in which he raises the specter of a Japan-style period of extended deflation. James Bullard, president of the Federal Reserve Bank of St. Louis, argues that new, large-scale quantitative easing -- or purchases of government bonds and other assets -- would be a policy tool to prevent that possibility, though he doesn't specifically endorse such a policy explicitly.
Here is the executive summary of Bullard's paper, and the full document, with the ominous title "Seven Faces of 'The Peril.' " His two main conclusions: that the Fed's commitment to leave rates low for an extended period "may be increasing the probability of a Japanese-style outcome for the U.S.," and that "on balance, the U.S. quantitative easing program offers the best tool to avoid such an outcome."
Bullard's paper comes at a crucial time, as the Fed starts to weigh whether the risk of deflation and extended weak growth is high enough to warrant new action. Chairman Ben S. Bernanke indicated openness to new policy steps to boost growth in congressional testimony last week, but made clear that they would only be undertaken if conditions worsen further.
Bullard's analysis adds to that debate in some interesting ways. Bernanke suggested that the Fed could promise to leave its short-term interest rates low for even longer than the "extended period" it has already. Bullard is calling that strategy potentially counterproductive.
His argument: Essentially that the pledge of low rates signals that Fed leaders expect inflation to keep falling, making it more likely that the economy settles into the deflation trap in which the Japanese economy is stuck.
It's particularly interesting to see Bullard raise the specter of deflation, because he is generally viewed as residing on the other side of Fed policy debates, on the inflation hawk side of things.
It's pretty clear from Bernanke's testimony last week that the chairman himself is not ready to take new action at the Aug. 10 Fed policy meeting, although that could change if there is some surprisingly weak economic data in the interim, including with Friday's GDP report and next Friday's jobs report.
If nothing else, the Bullard paper makes clear that Bernanke would have an ally in St. Louis if he concluded that it was time to pull out the stops for a new wave of monetary policy activism, and as such makes that outcome a bit more likely, even if it is not imminent.
July 29, 2010; 1:47 PM ET
Categories: Federal Reserve
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