Stephen Foley: It won't take much for fears of a lost American decade to become reality


US Outlook: If the stock market's reaction to his testimony before Congress this month doesn't jolt Federal Reserve chairman Ben Bernanke out of his complacency, then maybe the little tap on the shoulder he got from his colleague James Bullard might.

Mr Bullard, president of the St Louis branch of the Fed and a member of the central bank's monetary policy committee, just published a research paper saying the Fed might be talking the US into a Japan-style nightmare of deflation and sluggish economic activity.

US interest rates have been at zero since December 2008 and, at each meeting, the Fed's open market committee has reiterated its plan to keep rates "exceptionally low" for "an extended period". Mr Bullard argues that this incantation is starting to have a perverse effect. Instead of assuring business that the Fed will rev up the economy, and with it inflation, the words now seem to presage a world of persistently low rates and persistently low prices.

Deflation rightly scares central bankers. It is the great shriveller of economic activity, and there are no clear ways to stop it once it starts. In a deflationary environment, business and consumers reasonably ask: why do today what you can put off until it is cheaper tomorrow?

There are enough drags on the US economy as is. Large public and private debts have to be sweated off. An ageing population increasingly turns its face against the immigrants who might add some compensating dynamism. The quarterly earnings season just coming to a close has divided companies broadly into two camps, those who do business in Asia (who are upgrading their forecasts) and those who rely on the US (who are gloomy). It won't take much in this climate to turn fears of a US "lost decade" into a reality.

Mr Bullard is making the case for insurance. By contrast, Mr Bernanke, bafflingly, went out of his way to suggest indifference. The Fed chairman made no mention of contingency plans for a double dip recession in his testimony to the House or the Senate last week, and when asked what the bank might do if the economy did turn down, he made a half-hearted list that began with "further changes or modifications of our language describing how we intend to change interest rates".

As Mr Bullard points out, there is nowhere to go from zero in interest rate policy. If central banks want to have the sort of leverage over inflation expectations that they have in traditional, higher-rate environments, he said, then they have to open up the toolbox to quantitative easing. This from a traditionally hawkish economist. He is not arguing for any statement that the Fed will pump newly minted money into the economy by buying Treasuries; only that it is willing if needs be.

Having pulled quantitative easing out of the hat last year, and after numerous wonderful, unconventional tricks to ease the financial panic, Mr Bernanke is now reverting to pre-2008 type. His unwillingness to discuss levers other than interest rates is of a piece with his insistence that monetary policy ought not be used against asset bubbles and with the tardiness of his reaction to the credit crunch in 2007. For business leaders to regain their animal spirits, and the world's largest economy to regain its poise, we need a central bank that shows itself bolder and wiser than this. Under Mr Bernanke's chairmanship, the Fed has proved creative in a crisis, less so when it comes to preventing one. Mr Bullard's intervention is timely and welcome.

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