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Fed president: U.S. could face Japan-like crisis

The Federal Reserve should revive a crisis-era program to buy government debt if the U.S. seems headed toward a bout with deflation, a Fed official said Thursday.
/ Source: The Associated Press

The Federal Reserve should revive a crisis-era program to buy government debt if the country seems headed toward a bout with deflation, a Fed official said Thursday.

James Bullard, president of the Federal Reserve Bank of St. Louis, worries that the United States could tip into a Japanese-like bout of deflation if the economy weakens. Deflation is a widespread and prolonged drop in prices of goods, values of homes and stocks, and in wages.

Bullard, a voting member this year on the Fed's main policy-setting committee, is staking out his position as the Fed wrestles with what additional steps it should take to stimulate the economy if the recovery shows signs of backsliding.

Fed Chairman Ben Bernanke made clear to Congress last week that the Fed is ready to act, if needed. Bernanke said one option would be cutting to zero the interest rate paid to banks on money parked at the Fed. Another: providing more information about how long it will keep interest rates at record lows. The Fed chief also left the door open to relaunching programs to buy mortgage securities or government debt, the latter which Bullard says should be considered.

Bernanke and his colleagues meet next on Aug. 10. Economists don't think the Fed will announce new policy actions at that time, unless the economy were to seriously deteriorate before then. However, what specific elements should be part of a contingency plan are likely to dominate those discussions, analysts said.

For now, Bullard thinks the deflation risk is still low. But the danger could grow. Buying government debt would energize the economy and nip deflationary forces.

"It pays to think ahead about things that might happen," Bullard told reporters. "This is a matter of being ready, in case something else hits."

Last year, the Fed bought up to $300 billion worth of Treasury securities. It marked an unconventional move to pull the country out of its worst recession since the 1930s. At that time, the initiative sparked controversy from critics on Capitol Hill and elsewhere that the Fed was basically printing money to pay for rising budget deficits and debt.

In a paper released Thursday, Bullard also argued that the Fed's pledge to hold rates at record lows for an "extended period" is a "double-edged sword." The pledge could make investors, businesses and ordinary people down, think inflation could be heading lower, which could aggravate the risk of deflation.

America's last serious case of deflation was during the Great Depression in the 1930s. Japan was gripped with a period of deflation during the 1990s, and it took a decade for that country to overcome those problems.

Asked whether he would dissent from the Fed's pledge to hold rates at ultra-low levels for an extended period, Bullard, in remarks to reporters, neither committed to doing do, nor ruled it out.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, at the June meeting dissented from the Fed's pledge. It was the fourth consecutive meeting where he objected to that pledge. But his concerns were different from Bullard's.

Hoenig fears keeping rates too low for too long could lead to excessive risk-taking by investors and feed new speculative bubbles in the prices of stocks, bonds and commodities. He's also expressed concern that low rates could eventually unleash inflation.

There are differences of opinion within the Fed about what new steps should be taken in case of an economic backslide. And, there's also unease about taking any new action.

Still, "there is momentum growing to have a contingency plan in place. How do we get the economy out of its funk. That is already the becoming the highest priority," said Brian Bethune, economist at IHS Global Insight.

In the end, Bethune believed Fed members would ultimately back the approach favored by Bernanke. The Fed chief has publicly kept his options open and has said he hasn't come up with a short list of options.

Richard Fisher, president of the Federal Reserve Bank of Dallas, in a speech Thursday said he expects the recovery to stay intact, but warned it will be slow.

"I fear that nation's economy will be sailing forward at suboptimal speed" despite record low rates and all the other stimulative actions taken by the government, he said.

Fisher, who has a reputation for being an inflation hawk like Hoenig, didn't speak on whether new stimulative steps should be taken by the Fed.