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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.

By Neil Irwin  |  July 29, 2010; 1:47 PM ET
Categories:  Federal Reserve  
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Comments

I've lost count of how many times this idiot has called for printing more money and purchasing assets in the last three years. Inaccurately calling him an inflation hawk is just a way to give him more credibility as a central banker than he deserves.

Posted by: leshoro | July 29, 2010 2:48 PM | Report abuse

anyone who has done any regular retail shopping over the past five years knows full well there is seriously depressed consumer demand that has been reflected in price cutting at the retail level that has not abated.

home depot in Ukiah California giving away for free 10lb bags of Sluggo snail bait to anyone making a purchase in the garden department not as a promotion "because we bought so much and it stopped selling it is just going to go bad."

A Lowe's store in Rancho Cordova California that opened two years ago and still has an employee to customer ratio of 10 to one on any day other than Saturday and even them sometimes...

Safeway has adopted the Wal-Mart pricing protocol.

Who could expect anything different in an economy that relies on consumer spending for 70 to 80 percent its inputs and has had 20 percent unemployment for at least two years and some would argue for more than a decade.

Tax cutting, dismantling manufacturing base and zero investment in infrastructure chickens coming home to roost.

Posted by: Anonymous | July 29, 2010 5:46 PM | Report abuse

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