Deflation, is that like depression?
Falling prices and wages happens when there is a smaller market for goods and services and people are overpaid when labor costs are compared to the global average, assuming equal pay for equal work. That is YankeeJim’s explanation.
I have been writing for some time now that US workers are often paid too much for what they do. Too many people are laid off and available to work, though to energize business with their availability, they must work for less.
If workers are working for less, even as more enter the work force, there still is the matter of grossly overpriced real estate. The price of real estate must come in line that translates to falling prices.
If workers and real estate owners won’t make rapid adjustments, then the entire process drags on for a longer period. You cannot fool the propensity to achieve a corrected equilibrium. It will happen no matter what you do.
“Fed member's deflation warning hints at policy shift
Warning of 'Japanese-style' crisis shows deepening concern about recovery
A subtle but significant shift appears to be occurring within the Federal Reserve over the course of monetary policy amid increasing signs that the economic recovery is weakening.
On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
The warning by Mr. Bullard, who is a voting member of the Fed committee that determines interest rates, comes days after Ben S. Bernanke, the Fed chairman, said the central bank was prepared to do more to stimulate the economy if needed, though it had no immediate plans to do so.
Mr. Bullard had been associated with the camp that sees inflation, the Fed’s traditional enemy, as a greater threat than deflation.
But with inflation now very low, about half of the Fed’s unofficial target of 2 percent, and with the European debt crisis having roiled the markets, even self-described inflation hawks like Mr. Bullard have gotten worried that growth has slowed so much that the economy is at risk of a dangerous cycle of falling prices and wages.
Among those seen as already sympathetic to the view that the damage from long-term unemployment and the threat of deflation are among the greatest challenges facing the economy, are three other Fed bank presidents: Eric S. Rosengren of Boston, Janet L. Yellen of San Francisco and William C. Dudley of New York.
As the Fed’s board of governors shifts, the doves are getting more attention.
President Obama has nominated Ms. Yellen to be vice chairwoman of the Fed. The Senate Banking Committee voted 17 to 6 on Wednesday to confirm her, though the top Republican on the panel, Senator Richard C. Shelby of Alabama, voted no, saying he believed Ms. Yellen had an “inflationary bias.”
Mr. Obama’s two other nominees, Peter A. Diamond and Sarah Bloom Raskin, who like Ms. Yellen are on track to be confirmed by the Senate, have also expressed serious concerns about unemployment.
Whether the Fed should take new and untested actions to support the economy is certain to be the top agenda item when the Federal Open Market Committee, which sets monetary policy, meets on Aug. 10. The committee includes the Fed’s board of governors, along with the president of the New York Fed and a rotating group of the other bank presidents.
Mr. Bullard, in an conference call with reporters on Thursday, said he was not calling right away for the Fed to drop its position that interest rates would remain exceptionally low for “an extended period,” or to resume buying long-term Treasury securities to stimulate the economy.
But both steps, he said, should be taken if any new “negative shocks” roil the economy.
“This is very significant,” Laurence H. Meyer, a former Fed governor, said of Mr. Bullard’s new position. “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.”
Until now, Mr. Rosengren of the Boston Fed had been perhaps the Fed official most outspoken on the prospect of the economy getting mired in a deflationary cycle.
“While I am not anticipating we will be in a deflationary period, it’s a risk that I do take seriously, and we should continue to monitor what’s happening with prices,” Mr. Rosengren said in an interview last week. “A heightened risk of deflation is something that we should react to.”
That view is not universally held, however.
“I think the fear of deflation in and of itself is probably overblown, from my perspective,” Charles I. Plosser, president of the Philadelphia Fed, said last week in an interview. He said that inflation expectations were “well anchored” and noted that $1 trillion in bank reserves was sitting at the Fed. “It’s hard to imagine with that much money sitting around, you would have a prolonged period of deflation,” he said.
Richard W. Fisher, president of the Dallas Fed, said in an interview this week: “Reasonable people can argue that there’s a risk of deflation, but we haven’t seen it in the numbers yet.”
These two regional bank presidents, along with Thomas M. Hoenig of the Kansas City Fed, are associated with the hawkish camp within the Fed whose focus is continued vigilance on inflation.
Starting in 2007, the Fed lowered the benchmark short-term 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.
Those purchases were phased out in March, but there is now talk within the Fed of resuming them. Doing so would further enlarge the central bank’s balance sheet, which has more than doubled, to $2.3 trillion.
To buy all those assets, the Fed essentially printed money — the $1 trillion in reserves. If the reserves were withdrawn and lent out quickly, the supply of money in the economy could increase rapidly.
But right now there seems to be little threat of that happening. Bank lending has continued to contract. Big companies are in essence sitting on piles of cash, while many small businesses complain that getting a bank loan has gotten much tougher.
“The inconceivable is becoming increasingly conceivable,” Mr. Rosengren said. “As a result, I think it has become clear that just the creation of reserves, in and of themselves, isn’t going to become inflationary and shouldn’t affect inflation expectations, unless you see a banking system that is growing rapidly and starting to increase lending.”
He added: “At that point, we should start contracting both monetary and fiscal policy, and I would welcome when that occurs. But we’re not at that point right now.” “