Arrow-right Camera
The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Fed leaders split on fighting deflation

St. Louis director favors buying more U.S. Treasury debt

Jeannine Aversa Associated Press

WASHINGTON – Debate is intensifying at the Federal Reserve over how best to cope with a weakening recovery, with momentum growing for a concrete plan to prevent a backslide into recession.

That came into view Thursday as James Bullard, president of the Federal Reserve Bank of St. Louis, offered a specific proposal. He said the Fed should revive a crisis-era program to buy government debt if the country seems headed toward a bout with deflation.

Fed Chairman Ben Bernanke has yet to endorse precise steps, only saying that the Fed is ready to act if needed. He has mentioned possibilities, while committing to none.

And one Fed official has dissented all year over the Fed’s pledge to keep interest rates at record lows, pointing to some unease inside the central bank over taking any new steps to stimulate growth.

Bernanke and his colleagues meet next on Aug. 10. Economists don’t think the Fed will announce new policy actions at that time, unless the economy were to seriously deteriorate before then. However, what specific elements should be part of a contingency plan are likely to dominate those discussions, analysts said.

Bullard, a voting member this year on the Fed’s main policy-setting committee, worries that the United States could tip into a Japanese-like bout of deflation if the economy weakens. Deflation is a widespread and prolonged drop in prices of goods, values of homes and stocks, and in wages.

For now, Bullard thinks the deflation risk is still low. But the danger could grow. Buying government debt would energize the economy and nip deflationary forces.

“It pays to think ahead about things that might happen,” Bullard told reporters. “This is a matter of being ready, in case something else hits.”

Bernanke told lawmakers on Capitol Hill last week that the Fed policymakers had several options if the economy worsens.

They could cut to zero the interest rate paid to banks on money parked at the Fed. They could also provide more information about how long it will keep interest rates at record lows. And the Fed chief left the door open to relaunching programs to buy mortgage securities or government debt, the latter which Bullard says should be considered.

Last year, the Fed bought up to $300 billion worth of Treasury securities. At that time, the initiative sparked controversy from critics on Capitol Hill and elsewhere that the Fed was basically printing money to pay for rising budget deficits and debt.

In a paper released Thursday, Bullard also argued that the Fed’s pledge to hold rates at record lows for an “extended period” is a “double-edged sword.” The pledge could make investors, businesses and ordinary people think inflation could be heading lower, which could aggravate the risk of deflation.

America’s last serious case of deflation was during the Great Depression in the 1930s. Japan was gripped with a period of deflation during the 1990s, and it took a decade for that country to overcome those problems.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, at the June meeting dissented from the Fed’s pledge. It was the fourth consecutive meeting where he objected to that pledge. But his concerns were different from Bullard’s.

Hoenig fears keeping rates too low for too long could lead to excessive risk-taking by investors and feed new speculative bubbles in the prices of stocks, bonds and commodities. He’s also expressed concern that low rates could eventually unleash inflation.

There are differences of opinion within the Fed about what new steps should be taken in case of an economic backslide. And, there’s also unease about taking any new action.

Still, “there is momentum growing to have a contingency plan in place. How do we get the economy out of its funk. That is already the becoming the highest priority,” said Brian Bethune, economist at IHS Global Insight.

In the end, Bethune believed Fed members would ultimately back the approach favored by Bernanke.