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Fed Member’S Deflation Warning Hints At Policy Shift

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A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy amid increasing signs that the economic recovery is weakening.

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

The warning by Mr. Bullard, who is a voting member of the Fed committee that determines interest rates, comes 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.

Mr. Bullard had been viewed as a centrist and associated with the camp that sees inflation, the Fed’s traditional enemy, as a greater threat than deflation.

But with inflation now very low, about half of the Fed’s unofficial target of 2 percent, and with the European debt crisis having roiled the markets, even self-described inflation hawks like Mr. Bullard have gotten worried that growth has slowed so much that the economy is at risk of a dangerous cycle of falling prices and wages.

Among those seen as already sympathetic to the view that the damage from long-term unemployment and the threat of deflation are among the greatest challenges facing the economy, are three other Fed bank presidents: Eric S. Rosengren of Boston, Janet L. Yellen of San Francisco and William C. Dudley of New York.

As the Fed’s board of governors shifts, the doves are getting more attention.

President Obama has nominated Ms. Yellen to be vice chairwoman of the Fed. The Senate Banking Committee voted 17 to 6 on Wednesday to confirm her, though the top Republican on the panel, Senator Richard C. Shelby of Alabama, voted no, saying he believed Ms. Yellen had an “inflationary bias.”

Mr. Obama’s two other nominees, Peter A. Diamond and Sarah Bloom Raskin, who like Ms. Yellen are on track to be confirmed by the Senate, have also expressed serious concerns about unemployment.

Whether the Fed should take new and untested actions to support the economy is certain to be the top agenda item when the Federal Open Market Committee, which sets 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.

Mr. Bullard, in an conference call with reporters on Thursday, said he was not calling right away for the Fed to drop its position that interest rates would remain exceptionally low for “an extended period,” or to resume buying long-term Treasury securities to stimulate the economy.

But both steps, he said, should be taken if any new “negative shocks” roil the economy.

“This is very significant,” Laurence H. Meyer, a former Fed governor, said of Mr. Bullard’s new position. “He has been one of the most hawkish members, but he is now calling for the Fed to ease aggressively. There seems to be no question he wants to do it sooner rather than later, and relatively forcefully.”

Until now, Mr. Rosengren of the Boston Fed had been perhaps the Fed official most outspoken on the prospect of the economy getting mired 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,” Mr. Rosengren said in an interview. “A heightened risk of deflation is something that we should react to.”

That view is not universally held, however.

“I think the fear of deflation in and of itself is probably overblown, from my perspective,” Charles I. Plosser, president of the Philadelphia Fed, said last week in an interview. He said that inflation expectations were “well anchored” and noted that $1 trillion in bank reserves was sitting at the Fed. “It’s hard to imagine with that much money sitting around, you would have a prolonged period of deflation,” he said.

Richard W. Fisher, president of the Dallas Fed, said in an interview this week: “Reasonable people can argue that there’s a risk of deflation, but we haven’t seen it in the numbers yet.”

These two regional bank presidents, along with Thomas M. Hoenig of the Kansas City Fed, are associated with the hawkish camp within the Fed whose focus is continued vigilance on inflation.

The slow drip feed into the press about deflation before the Fed cranks up the printing press?

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Some on here do not believe in deflation. Or, to put it another way, the "cycle" is not really a cycle at all but a one-way inflationary track.

Yap indeed - deflationist - please provide a single deflation example where cost of living not adjusted for hedonics and excluding house price (not rental

value) that actually goes down over say a 3 year period...

Just quoted in HPC blog Big Mac in Japan in 2002 was Y292, in 2009 it is Y320 (and it is probably a smaller one, so like for like probably more than Y320), so much for 'deflation'.

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