St Louis Fed: U.S Has Escaped Japanese-Style Deflation; Fed Must Look at Bubbles

James Bullard, president of the Federal Reserve Bank of St Louis and a a voting member of the Federal Reserve’s says the US has escaped the danger of a Japanese-style deflation.

According to him, that was the main concern in 2009, but that risk has now passed.

I am not sure that is an optimist view or just the opposite, meaning high-inflation is on its way.

Bullard says he is happy to continue with the current guidance in terms of interest rates, but added that added that, although it was not time to tighten policy, members of the Fed's policy setting committee would weigh in their decisions factors other than inflation and unemployment.

This includes considering asset bubbles.

“I think they’re gaining weight with many people because of the bad experience we had in the aftermath of the last recession, the housing bubble and how that really has blown up and caused so many problems,”.

“I think what the operating regime will really look like going forward is an open question and one that the committee is working on,”

According to an interview to the Financial Times, Mr. Bullard also emphasised that "an end to the unusually low spread of 25 basis points between the discount rate and the interest rate paid on reserves held at the Fed should not be seen as an immediate precursor to a general tightening of monetary policy".

“I think it makes sense today to think about it in terms of a liquidity context,” he said. “The reason it’s so low is exactly because we’re trying to address a huge crisis and a very special situation.” The broader post-crisis economy was “on track” with its recovery, he said. “It’s not a real strong recovery but that’s what we had predicted anyway. But it will be above-average growth for the first half of 2010 and we’ll probably see some positive jobs growth in the first part of 2010 here.”

On political interference

“I think it’s dangerous for America and dangerous for a global economy to try to divorce this central bank from true understanding of financial markets, and I think that that’s the direction we’ll be going in if we separated out the central bank from regulation,”

“What this crisis has shown is that our understanding of financial mediation and how it can impact on macro economy was not good enough. So what you want is to force the central bank to get better understanding and more information about financial markets as they’re making monetary policy decisions.”