From today's NY Times online:
http://www.nytimes.com/2010/07/30/business/economy/30fed.html?hp">Fed Member’s Deflation Warning Hints at Policy Shift
WASHINGTON — 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.
...
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.
So - now the Fed's worried about years of Japanese-style deflation.
Reading this, I thought I recalled that Paul Krugman - the Nobel Prize-winning economist who policymakers love to shun - has been warning about this for a year or more.
Sure enough.
Four days before Obama's inauguration,
http://krugman.blogs.nytimes.com/2009/01/16/the-tips-spread/">Krugman wrote:
Bear in mind that the Fed tries to keep inflation expectations “anchored.” Too low is as bad, or worse, than too high — because if expected inflation is low or negative, even a zero interest rate isn’t that good a deal, and the Fed may have a hard time booting us out of a recession. Normally the Fed wants expected inflation to be in the 2-2 1/2 percent range.
Whoops.
More and more, this looks like a Japan-type trap.
http://krugman.blogs.nytimes.com/2009/07/02/smells-like-deflation/">In July of last year:
Bear in mind that inflation usually runs below the rate of wage change, thanks to productivity growth. So we’re really heading into Japanese-style deflation territory.
And
http://krugman.blogs.nytimes.com/2009/07/10/economists-oppose-more-stimulus/">a few days later:
So they’re not saying that everything’s OK, no stimulus needed. They’re saying that they don’t like stimulus. And why should you be surprised? These are business economists; they’re generally conservative.
...
Aside from the value judgments, one thing I find really puzzling in this set of forecasts is the view on inflation.
Now, if you think that unemployment is going to be at or above current levels for the next 18 months, wouldn’t you think there would be a significant risk of deflation? In fact, however, the average forecast is for an inflation rate of 1.7 percent next year. What’s the logic?
Bottom line: when I look at those unemployment projections, they look very bleak, and suggest that we’re in serious danger of falling into deflation. That is, to me they make the case FOR another stimulus.
And from this May:
http://krugman.blogs.nytimes.com/2010/05/25/inflation-deflation-japan/">Inflation, Deflation, Japan
First, here’s a prime example of the fire-in-Noah’s-flood syndrome: Irwin Kellner manages to get all scared about inflation in the face of a deflationary environment. To do this, he has to come up with a novel theory: that the prices that matter are those of things we buy frequently, as opposed to big-ticket items bought less frequently. And the reason for this is …??? (Remember, there’s a very clear reason for excluding food and energy prices; I have no idea why big-ticket items should receive the same treatment.)
Why care about Kellner? Because he represents a significant body of opinion, which is basically worried because of the expansion of the monetary base. Yet both logic and experience show that when you’re in a liquidity trap, big rises in the monetary base aren’t inflationary — in fact, they can be virtually irrelevant.
He warned, he was shunned and scorned... now here we are.
I can only hope that our policy makers wake up, open their eyes, and start to embrace Krugman. Continuing to use "magic thinking" to deny experts like Krugman can never end well.
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