Fed official hints at growing fear of deflation

St. Louis bank president’s remarks suggest high unemployment may help spur policy shift

By Sewell Chan
New York Times / July 30, 2010

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WASHINGTON — A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy as the economic recovery is weakening.

James Bullard, president of the Federal Reserve Bank of St. Louis, yesterday warned that the Fed’s policies were putting the economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.’’

The warning by Bullard, who is a voting member of the Fed committee that determines interest rates, came days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed, though it had no immediate plans to do so. Today, the government will release its estimate of gross domestic product for the second quarter of this year.

At the Fed, Bullard had been associated with the camp that sees inflation, the central bank’s traditional enemy, as a greater threat than deflation brought on by anemic growth.

Until now he had not been an advocate for large-scale asset purchases to reinvigorate the economy.

But with inflation very low, about half of the Fed’s implicit target of 2 percent, and with the European debt crisis having roiled the markets, even self-described inflation hawks like Bullard have gotten worried about the economy’s trajectory.

Bullard appeared to join other Fed officials already seen as sympathetic to the view that damage from long-term unemployment and the threat of deflation are the greatest challenges facing the economy. They include the Fed bank presidents Eric S. Rosengren of Boston and William C. Dudley of New York.

Those inflation doves are likely to be joined soon by three new members of the Fed’s board of governors.

President Obama has nominated Peter A. Diamond, an economist, and Sarah Bloom Raskin, a bank regulator, to the Fed’s board, along with Janet L. Yellen, president of the San Francisco Fed, to be vice chairwoman of the board. All have also expressed serious concerns about unemployment.

Whether the Fed should take additional measures to support the economy is certain to be the top item when the Federal Open Market Committee, which shapes monetary policy, meets on Aug. 10. The committee includes the Fed’s board of governors, along with the president of the New York Fed and a rotating group of the other bank presidents.

Bullard, in a conference call with reporters yesterday, said that if any new “negative shocks’’ roiled the economy, the Fed should alter its position that interest rates would remain exceptionally low for “an extended period,’’ or resume buying long-term Treasury securities to stimulate the economy.

Laurence H. Meyer, a former Fed governor, said of Bullard’s new position: “This is very significant. He has been one of the most hawkish members, but he is now calling for the Fed to ease aggressively.’’

Until now, Rosengren had been perhaps the Fed official most outspoken on the prospect of the economy getting stuck in a deflationary cycle.

“While I am not anticipating we will be in a deflationary period, it’s a risk that I do take seriously, and we should continue to monitor what’s happening with prices,’’ Rosengren said in an interview last week. “A heightened risk of deflation is something that we should react to.’’

That view is not universally held, however.

Thomas M. Hoenig, president of the Kansas City Fed and an inflation hawk, said in an interview yesterday that the comparisons to Japan were overstated. He likened the debate to the situation in mid-2003, when a sluggish recovery from the 2001 recession prompted predictions of deflation that did not come to pass.