Regional Fed Presidents Back More Policy Action Against Deflation Threat
Two regional Federal Reserve presidents said the central bank should consider more policy action to stimulate the economy while seeking to avert a debilitating, broad-based decline in prices.
Chicago Fed President Charles Evans, speaking at a Boston Fed conference yesterday, advocated targeting a path for the price level as a way to stop the inflation rate from falling. He said the U.S. economy is in a liquidity trap and more accommodation is not a “close call.” Boston’s Eric Rosengren said “insuring against the risk of deflation may be much cheaper than” trying to eradicate it after it takes hold.
Fed Chairman Ben S. Bernanke and the Federal Open Market Committee are considering strategies, before their Nov. 2-3 policy meeting, to raise inflation expectations and purchase additional assets to help reduce unemployment persisting at more than 9 percent. Bernanke said in a speech opening the conference that there appears to be a “case for further action.”
Evans said further action was needed because the U.S. is caught in a “bona fide liquidity trap” where additions to the money supply fail to stimulate the economy. “This belief is not a new development for me; instead it is a dawning realization,” Evans said to the Boston Fed’s 55th Economic Conference.
Evans’ comments are among the strongest of any Fed official in favor of additional easing steps. With projections for unemployment to be at 8 percent and for inflation excluding food and energy to be at 1 percent by the end of 2012, “the Fed’s dual mandate misses are too large to shrug off,” Evans said.
He gave his support to a target for the path of the price level over a “reasonable period of time” that is communicated “regularly and often” to the public. Such a policy could complement large-scale asset purchases and be a change to the FOMC’s statement to include a pledge to keep rates near zero for longer than “an extended period.”
Targeting a path for the price level would help the Fed push inflation higher “for a time,” Evans said. The central bank would need to state the terms for exiting the policy, he said.
“I’ll admit that my views on this are evolving,” Evans said in response to audience questions at the conference.
“The central banks of the world, including ours, have been on an inflation targeting regime and moving to a brand new regime like that is quite difficult to explain” and poses “the danger of undermining credibility,” said Alan Blinder, a former Fed Vice Chairman and now an economist at Princeton University.
Some Fed officials are concerned that expectations of lower inflation will become self-fulfilling, damping demand by increasing borrowing costs in real terms, minutes of the September meeting said. By encouraging Americans to believe prices will start rising at a faster pace, the Fed would reduce inflation-adjusted interest rates and stimulate the economy.
Japan’s battle with deflation shows policy makers should take action to stimulate growth before price levels drop, Rosengren said.
The Bank of Japan pledged last week to keep its benchmark interest rate at “virtually zero” until deflation has ended, after first introducing the rate policy in 1999. Japan also created a fund to buy government debt and other assets.
“The fact that Japan is still battling deflation highlights how pernicious deflation can be, and how difficult it is to counteract once it has been firmly established,” Rosengren said.
In the minutes, the Fed gave several options for raising short-term price expectations, including providing more information on the inflation rate policy makers consider consistent with their long-term goals and targeting a path for the price level. For the first time, the Fed said it could also target a path for nominal gross domestic product, which isn’t adjusted for inflation.
Treasuries fell on Oct. 15, driving 30-year yields to a two-month high, and the Dollar Index rebounded from its 2010 low amid confidence Bernanke will succeed in stoking inflation. U.S. stocks rose as technology shares rallied, overshadowing losses in banks and General Electric Co.
Fed presidents rotate voting on monetary policy. Evans doesn’t vote on the rate-setting FOMC this year. He votes every other year on the FOMC, as does Cleveland Fed President Sandra Pianalto. Rosengren votes this year.
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