Seven Faces of “The Peril” -- Deflation

By James Bullard
President, St. Louis Fed

In this paper I discuss the possibility that the U.S. economy may become enmeshed in a Japanese-style, de‡ationary outcome within the next several years.

To frame the discussion, I rely on an analysis that emphasizes two possible long-run outcomes (steady states) for the economy, one which is consistent with monetary policy as it has typically been implemented in the U.S. in recent years, and one which is consistent with the low nominal interest rate, de‡ationary regime observed in Japan during the same period.

The data I consider seem to be quite consistent with the two steady state possibilities. I describe and critique seven stories that are told in monetary policy circles regarding this analysis. I emphasize two main conclusions: (1) TheFOMC’s extended period language may be increasing the probability of a Japanese-style outcome for the U.S., and (2) on balance, the U.S. quantitative easing program o¤ers the best tool to avoid such an outcome.

IS THE RISK OF DEFLATION RISING AGAIN?

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clipped from www.capitalspectator.com IS THE RISK OF DEFLATION RISING AGAIN? Last week, I advised that the unusual rallies in the dollar and gold this year may be a warning sign that deflationary winds are starting to blow harder. Historically, one falls as the other rises. The fact that both are climbing suggests the markets are worried about deflation...again. Today's report on April consumer prices only strengthens the case for thinking that the "D" risk is climbing once more. It may be a false warning, but it's getting harder to ignore.

Swiss slide into deflation signals the next chapter of this global crisis

"This is something that we must prevent at all costs. The current situation is extraordinarily serious," said Philipp Hildebrand, a governor of the Swiss National Bank.

The SNB is not easily spooked. It is the world's benchmark bank, the keeper of the monetary flame. Yet even the SNB's hard men have thrown away the rule book, taking emergency action to force down the exchange rate of the Swiss franc.

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The Big Fight Against Deflation

Sometimes you have to look beyond the obvious. It should be clear that the state of angst over the potential for deflation to bring down the financial system is enormous. The Federal Reserve announcement that they will be buying Treasuries, mortgage backed securities, and agency securities is clearly aimed at bringing liquidity back into the market. If 30 year mortgages were to fall to 4.5 percent, and if all homeownwers were able to refinance, it would create about $200 billion in cash flow savings to the consumer.

However, there are still many question that need to be answered. Will all consumers be able to refinance? What will consumers do with these cash flow savings? Will consumers spend or save? Will lower mortgage interest rates bring the supply and demand of houses into balance, or will the market continue to suffer from over supply?

The big questions is--what will be the longer term effects of the monetization of debt by the Federal Reserve? Short term this policy should bring an end to the deflations psychology. This is needed. It will bring liquidity into all debt markets; but, at what price? The monetization of debt right now looks like the necessary strategy in the short term. I agree. But, I have severe reservations about the long term.

The goal right now is to get us out of recession.

Is this new strategy a panacea or is it a Pandora's box? We will be looking at this over the weekend.

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Bob DeMarco is a citizen journalist and twenty year Wall Street veteran. Bob has written more than 500 articles with more than 11,000 links to his work on the Internet. Content from All American Investor has been syndicated on Reuters, the Wall Street Journal, Fox News, Pluck, Blog Critics, and a growing list of newspaper websites. Bob is actively seeking syndication and writing assignments.

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Roubini on Global Recession, Credit Crunch, and Deflation (Part Two)

Part two of Nouriel Rubini's speech at the 2009 CBOE Risk Management Conference. He discusses several topics including: the credit crunch,  global recession, and deflation.

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Fed Officials Worry Inflation Rates Could Ease Too Much

Key words: Fed’s efforts to purchase debt--Fed’s efforts to purchase debt.

clipped from blogs.wsj.com Federal Reserve officials at the annual meeting of the American Economic Association indicated they are growing more worried that inflation rates could get too low. With gasoline prices tumbling, the year-to-year change in the consumer price index is likely to tip into negative territory in the months ahead. Meantime, increases in core consumer prices, which exclude food and energy, have slowed sharply in recent months. Fed officials don’t foresee deflation happening, but they’d like to avoid even getting close to it. “It is especially important in such circumstances for the Fed to emphasize its commitment to returning inflation over time to the higher levels that are most appropriate to the attainment of its longer-term objectives,” Ms. Yellen said. The Fed’s balance sheet has ballooned from less than $900 billion to more than $2 trillion since September Fed’s efforts to purchase debt “have only just begun.”

Deja Vu Stagflation and the Savings Rate

Real disposable incomes (inflation-adjusted and after taxes) increased 0.1%, matching December with the lowest in nine months. A puny gain for sure and a possible sign that it could be negative next month. A sign of Stagflation?

Real (inflation-adjusted) consumer spending growth slowed to 0.2%, the weakest gain since August. Spending had risen 0.3% in January. Another potential bad sign.

The Fed could soon be facing both accelerating inflation and a slowing economy. And, this is my expectation.

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