The Federal Reserve is considering new action to simultaneously stimulate the economy and prevent the possibility of deflation. Charles Evans, President of the Chicago Fed, recently said that the central bank needs to act to prevent the inflation rate from falling, saying the U.S. economy faces a “bona fide liquidity trap” and that additional accommodation is not even a “close call.” Boston Fed President Eric Rosengren, agrees, noting “insuring against the risk of deflation may be cheaper than” attempting to deal with it once it becomes a reality.
Fed Chairman Ben Bernanke is working with the Federal Open Market Committee (FOMC) to devise a strategy to purchase additional assets aimed at averting deflation and cutting the nine percent unemployment rate, noting that there is a “case for further action.” Evans supports a “reasonable period of time” as long as it is communicated “regularly and often” to the public. This type of policy would complement large asset purchases and represent a change to the FOMC statement that they will keep interest rates close to zero for “an extended period.”
“The central banks of the world, including ours, have been on an inflation targeting regime and moving to a brand new regime like that is quite difficult to blame,” said Alan Blinder, formerly a Fed Vice Chairman and currently a Princeton economist. The action poses “the danger of undermining credibility.” Other Fed officials are worried that the expectation of lower inflation will become a self-fulfilling prophesy. That might impede demand by increasing the cost of borrowing money.