A warning that deflation could set in as U.S. economic recovery weakens was sounded by James Bullard, the president of the Federal Reserve Bank of St. Louis, Thursday. Preventing inflation has been the focus of Federal Reserve as it formulates policies to guide the U.S. economy out of the recession. The economy might be weakened by a Japanese style deflation if, as Bullard predicted, the policies of the Federal Reserve continue.
Deflation might be what happens instead of inflation
A drop in goods, services, homes, stocks, and wages is what a deflation is by definition. Preventing inflation has been what the Federal Reserve has tried doing, reports the New York Times. Starting in 2007, the Fed lowered the benchmark interest rate all the way to zero and pumped some $2 trillion into the economy with an array of emergency loans and purchases of government debts and mortgage bonds. To purchase all those assets, the Fed basically printed money — the $1 trillion in reserves. Inflation occurs when the money is taken out and given away when more money is just made.
A recipe for deflation
March was when the Fed finally quit getting government debt. Now the recovery no longer is in sight and inflation seems unlikely. Bank lending is contracting. Many companies just have a ton of money sitting around. Small businesses aren’t able to get loans from anyone. It will be a long time before the reserve money hits the rest of America. Unemployment is high. Home prices are going down and home sales appear to be at record lows still. These are all the reasons why Bullard thinks deflation might be near.
Info on the Japanese deflation
The 1990s was when this deflation started. A 1980s real estate bubble burst, banks took a bath on real estate loans, restricted lending and asset prices fell. Prices went down even further with imports becoming cheaper. The Bank of Japan and also the government tried to eliminate it by reducing benchmark interest rates. The bubble’s collapse lasted for more than a decade with stock prices bottoming in 2003. More stocks went down in 2008 causing a global meltdown. In November 2009 Japan returned to deflation, according to the Wall Street Journal. 2.2 percent of consumer prices fell in the end of 2009.
'Double edged sword’ what benchmark interest rates considered
The Federal Reserve should begin taking the necessary precautions and listen to Bullard’s warning to try and stop all of this from happening. Bullard thinks, according to the Associated Press, the Federal Reserve saying they would keep rates this low for an “extended period” of time is really a “double-edged sword. Deflation might happen if this gives off the impression that inflation is getting lower. Bullard has his opinions saying that the government debt needs to be bought along with lifting the rate of interest cap so deflation doesn’t happen either.
Additional reading
New York Times
nytimes.com/2010/07/30/business/economy/30fed.html?_r=1 and amp;src=busln
Wall Street Journal
online.wsj.com/home-page
Associated Press
google.com/hostednews/ap/article/ALeqM5hTlA7m2TuKuKz6FcqFx3b34S1lAQD9H8SA0G2
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