A warning of deflation was announced by the President of the Federal Reserve Bank of St. Louis, James Bullard, because the U.S. economy has gotten so bad. The Federal Reserve has tried throughout the whole recession to prevent inflation from happening. The economy might be weakened by a Japanese style deflation if, as Bullard predicted, the policies of the Federal Reserve continue.
Deflation because of inflation prevention
If a deflation were to occur, that would mean the prices of goods, services, homes, and stocks would drop. According to the New York Times, the Fed has tried very hard to stop inflation from happening. Starting in 2007, the Federal Reserve rate of interest became zero when many emergency loans and government purchases were given out with about $2 trillion. To buy 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 to create deflation
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. Banks refuse to lend. Big companies pulled out their cash and are just waiting for things to get better now. Small business loans are almost obsolete. It could be a long time before the reserve money hits the rest of America. Unemployment is still really high. Home sales are at record lows and home prices are falling. Bullard, as well as others, think deflation could possibly be a possibility.
All about the Japanese deflation
Deflation started in Japan within 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 and also the government tried to eliminate it by reducing benchmark 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, according to the Wall Street Journal. Later within the year, 2009, all of the consumer prices reduces about 2.2 percent.
Benchmark interest rates are considered to be a ‘double edged sword’
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, as outlined by the Associated Press, the Federal Reserve saying they would keep rates this low for an “extended period” of time is really a “double-edged sword. If individuals think inflation is going down, then deflation is likely to happen. In addition to lifting the cap on the benchmark rate of interest, Bullard said resuming the purchase of government debt should be considered to prevent deflation if there is a new shock to the weakened economy.
Further reading
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
