Now that the Federal Reserve has pushed short-term interest rates to zero, some pundits are saying the central bank is out of recession-fighting ammunition. Not so, argues James Bullard, president of the St. Louis Federal Reserve Bank. In a speech today to the CFA Society of St. Louis, he emphasized that the Fed can do — and already is doing — a lot to stimulate the economy by expanding its balance sheet. (See page 7 of his slideshow for a graphic depiction of how the balance sheet has nearly tripled in size.)

You should not think of the Fed as being on the sidelines during the next year or two. What we’ve really lost is our ability to signal the private sector through nominal interest rate movements.

Instead of watching interest rates, he said, markets will have to pay attention to quantitative measures like the monetary base, which has expanded dramatically since September.

During his talk and an interview with reporters afterward, Bullard also discussed:

• Banks’ troubled assets. “I’m a little concerned that time hasn’t been a healer. … The asset problems that are permeating markets do not naturally go away. These information problems in financial markets need to be addressed directly.”
• Financial regulatory reform. “People are talking about regulatory reform in too casual a way. This a difficult issue and it’s a global issue. … If you want a reform that’s going to work, it’s going to be very difficult to design it.”
• Deflation. “The CPI for this year is not negative in my modal forecast, but I do think there’s downside risk …, so you could end up in negative territory.”
• The idea that the Fed should adopt a specific, formal inflation target. “Right now is when inflationary expectations … are really fluid. … This is exactly the time to say, we have an inflation target and we are committed to meeting that target. With this deflation threat, it would help you keep that at bay.”
• The housing market. “I think the bubble component is out of housing prices. The question now is how much overshooting are you going to get. Is this thing going to continue down below the fair value and then recover? Markets do overshoot.”