Thursday, July 29, 2010

President of St. Louis Federal Reserve concerned by prospect of deflation

WASHINGTON (AP) -- Debate is intensifying at the Federal Reserve over how best to cope with a weakening recovery, with momentum growing for a concrete plan to prevent a backslide into recession.

That came into view Thursday as James Bullard, president of the Federal Reserve Bank of St. Louis, offered a specific proposal. He said the Fed should revive a crisis-era program to buy government debt if the country seems headed toward a bout with deflation.

Bullard, a voting member this year on the Fed's main policy-setting committee, 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.

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.

I believe deflation is a very real and present danger to the economy given the paralyzing gut shot it has taken over the past two and a half years that has sucked out all the money and consequently left a large amount of slack in the economy. All that excess capacity of goods and services can't be bought up because consumers and small businesses don't have a lot of dollars in their pockets to spend on them. They become devalued as a result.

It will be difficult for the nation and its economic policymakers to cope with deflation after four decades of being geared to counteract the threat of inflation starting in the 1970s.

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