Bullard Concerned about Japanese-Style Inflation

If you’re worried about a deflationary spiral taking hold in the US, you’re not alone. James Bullard, president of the St. Louis Federal Reserve Bank and a member of the Fed’s Open Market Committee, has been an outspoken proponent of aggressive Fed action to prevent such an outcome.

In a paper titled “Seven Faces of ‘The Peril’,” which was recently published by the St. Louis Fed, Bullard argues that the Fed must take immediate action to stimulate the US economy, otherwise the economy could stagnate for years, much like Japan’s “lost decade,” when prices fell during a more than 10-year period.

Bullard believes that one of the few steps that the government can take, outside of fiscal stimulus, which Congress doesn’t look likely to implement, is to begin another quantitative easing program that would further lower long-term interest rates by purchasing massive amounts of financial assets. With most of the Fed on board, this program is likely to begin shortly after the Fed meeting during the first week of November.

The potential rewards of such an approach include lower long-term interest rates, which could spark business and consumer spending, resulting in lower unemployment and improved economic growth. This approach, in tandem with the bank bailout and economic stimulus package in 2008 and 2009, helped bring the US out of the Great Recession. But as economic growth has slowed, officials such as Bullard and Federal Reserve Chief Ben Bernanke are worried that a lack of economic growth is condemning the US to the economic wilderness of a long-term deflationary spiral.

The risks? Massive purchases of bonds will flood the economy with money, creating asset bubbles and risking high inflation during the long term. Bullard argues that such fears are overblown, because the risks of deflation are much higher and will be harder to beat than any asset bubbles or inflation. Indeed, a recent poll of economists by CNNMoney reveals that twice as many are worried about deflation than the return of inflation.

With deflation, prices fall during a long period of time. In such an environment, both consumers and businesses tend to hoard cash in the belief that prices will be lower in the future. As the Japanese example illustrates, once deflation takes hold, it is extremely difficult to stop. By beginning a policy of quantitative easing now, Bullard and his colleagues at the Fed hope to stop deflation now.

–Amy E. Buttell