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Fed official warns of deflation threat
A member of the Federal Reserve committee that sets interest rates warned today that the central bank's own policies threaten a Japanese-style bout of deflation within the next several years. The comments today by James Bullard, president of the Federal Reserve Bank of St. Louis, are his own, but The New York Times said this, and other signs, hint at a policy shift at the Fed amid a weakening recovery.
"The U.S. is closer to a Japanese-style outcome today than at any time in recent history," Mr. Bullard wrote in a paper posted on the Federal Reserve Bank of St. Louis website. "In part, this uncomfortably close circumstance is due to the interest rate policy being pursued by the [Federal Open Market Committee]. That policy is to keep the current policy rate close to zero, but in addition to promise to maintain the near-zero interest rate policy for an extended period. But it is even more than that, because the reaction to a negative shock in the current environment is to extend the extended period even further delay the day of normalization of the policy rate farther into the future. This certainly seems to be the implication from recent events."
A better avenue, he argued, is to expand the quantitative easing program by purchasing Treasury securities. Speaking to reporters, Mr. Bullard said he was not urging this be done immediately, but such measures should be taken if new shocks hit the economy.
“This is very significant,” Laurence Meyer, a former Fed governor, told The New York Times. “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.”
U.S. fiscal cracks showing
As Europe shows signs of beginning to climb out of its funk - economic sentiment in the euro zone is at its highest in more than two years, and German unemployment is falling - attention turns increasingly to the economic and fiscal woes of the United States. The euro, for example, today hit its best level since a massive bailout package was unveiled in early May, buoyed by ever stronger signs such as a dip in Germany's jobless rate and heightened sentiment in the euro zone.
In the United States, despite strong corporate earnings, economists continue to focus on the country's troubles. Scotia Capital currency strategist Sacha Tihanyi today points to yesterday's state of emergency by California's muscle-bound governor, Arnold Schwarzenneger.
California's troubles, he noted, didn't dominate headlines "despite the fact that without a budget (1 month overdue), the state is projected to run out of cash by October (at the latest." Markets, he said, are discounting the probability that California goes bust, and they assume a budget in place before the money runs out.
"But the size of California's economy and the delay in the fiscal process reminds us of the U.S. national fiscal situation," Mr. Tihanyi said. "We continue to be concerned over the lack of anything more than lip service by government officials being paid towards the need for U.S. fiscal consolidation, instead using double-dip recession fears as a buffer to political pressures. The euro's outperformance against the [U.S. dollar] today, with a break of the 1.3050 level, reminds us that the [U.S. dollar] can no longer rely on the sovereign risks of others to bolster its fortunes and keep government bond yields restrained."
