A warning of deflation was announced by the President of the Federal Reserve Bank of St. Louis, James Bullard, as the U.S. economy has gotten so bad. Preventing inflation has been the focus of Federal Reserve as it formulates policies to guide the U.S. economy out of the recession. But Bullard cautioned that Fed’s current policies to stimulate growth are putting the U.S. economy at risk of falling into a Japanese-style deflationary cycle that could keep the economy weak for several years.
Deflation because of inflation prevention
A drop in goods, services, homes, stocks, and wages is what a deflation is by definition. According to the New York Times, the Fed has tried very hard to stop inflation from happening. Starting in 2007, the Fed lowered the benchmark rate of interest all the way to zero and pumped some $2 trillion to the economy with an array of emergency cash 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.
How deflation happens
Government debt was no longer bought by the Federal Reserve beginning in March. Since then, the U.S. economic recovery has faltered and the threat of inflation is low. Lending is not an option for most banks right now. Big companies are sitting on piles of cash. Small businesses can’t get loans. It can be a long time before the reserve money hits the rest of America. Unemployment is nevertheless really high. Homes sales are nevertheless at record lows while they continue to fall. These are all the reasons why Bullard thinks deflation might be near.
Japanese deflation
Deflation started in Japan in the early 1990s. Asset prices fell following the 1980s real estate bubble burst causing more lending to be restricted. Cheap imports further lowered prices. The Bank of Japan made their mark by trying fix it with lower interest rates. In 2003 the stock market hit its all time low which shows how this problem lasted about a decade. More stocks went down in 2008 causing a global meltdown. In November 2009 Japan returned to deflation, as outlined by the Wall Street Journal. Consumer prices fell in October 2009 by a near record 2.2 percent.
'Double edged sword’ for interest rates
Deflation warnings are being sounded by Bullard, a voting member on the Fed’s main policy-setting committee, as the Fed considers additional steps it should take to stimulate the economy if the weak recovery falls back into recession. Bullard thinks that the Fed promise to keep rates low for an “extended period” is a “double-edged sword,” reports the Associated Press. Deflation might happen if this gives off the impression that inflation is getting lower. Bullard has his opinions saying the government debt needs to be bought along with lifting the interest rate cap so deflation doesn’t happen either.
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
