James Bullard has discussed deflation before, but he got more attention than usual when he brought up the subject last week.
Maybe the reaction reflects the strong language that Bullard, president of the St. Louis Federal Reserve Bank, used to describe the risk of a sustained drop in the price level. Or maybe the sluggish economy has made Americans hypersensitive to such danger.
Friday's report on the gross domestic product certainly did nothing to dispel the fears. The Commerce Department said GDP growth slowed noticeably in the second quarter, and it revised some earlier figures downward. In short, the recession was worse than we thought, and we're coming out of it more slowly than everyone had expected.
Bullard, in an academic-type paper published Thursday, discussed the risk that the U.S. will wind up like Japan, which has been battling deflation for more than a decade. He says we are "closer to a Japanese-style outcome today than at any time in recent history."
He also thinks the Federal Reserve should be trying to prevent that outcome. He suggests that the Fed stop talking about an "extended period" of low interest rates and instead consider reviving its quantitative easing program.
That's the program through which the central bank, after pushing short-term interest rates to zero, bought more than $1 trillion of long-term bonds in 2009 and early 2010. Most economists give the effort high marks, saying it helped keep the recession from turning into a depression.
Core inflation, however, is currently running at less than 1 percent a year. That's dangerously close to zero — and to negative territory. If consumers expect prices to decline over time, they hoard money and delay purchases for as long as they can.
Such deflationary psychology is hard to reverse once it gets started. Therefore, Bullard and others argue, we should do everything possible to keep it at bay.
Scott Colbert, head of fixed-income investments at Commerce Trust Co. in Clayton, thinks Bullard is right to worry about deflation. Debt-laden consumers, he says, will be tightening their belts for years or even decades.
"It (deflation) has a higher probability than the new inflationary spiral that other people are talking about," Colbert says. "There's no one right answer, but it is probably going to take some more monetary stimulus and more nontraditional measures to convince people that the Fed is not going to allow asset prices to fall."
Among economy watchers, there's a wide range of opinion on how ominous the deflation threat is. Most, though, are glad to see a central banker raising the alarm.
"We think the economy is just going through a normal slowdown after a first year of recovery," says Gary Thayer, chief macro strategist at Wells Fargo Advisors. "We don't think deflation is the most likely scenario, and we think the Federal Reserve still has policy options to prevent it."
"Anytime you have debt going bump in the night, deflation is a threat," says Bob Doll, chief equity strategist at New York investment firm BlackRock. "It looms, the Fed needs to know what to do if we go there, but I don't think we are going there yet."
One thing's for sure: We don't want to end up like Japan, which has been unable to shake the deflation that set in after its stock-market and real-estate bubbles burst in the 1990s. If Bullard, who has spent his career building a reputation as an inflation fighter, is worried about deflation, the rest of us should worry, too.
