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Fed leaders show split on deflation

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WASHINGTON — The Federal Reserve disclosed Wednesday that its chief policymakers were divided on whether the weak economy faced a new, potentially dangerous threat in the form of deflation.

The dissent within the Fed emerged as the White House released a report estimating that its economic stimulus program had saved or created 2.5 million to 3.6 million jobs since it was enacted, over nearly unanimous Republican opposition, at the start of President Barack Obama’s term.

The estimates in the report were in line with those of the nonpartisan Congressional Budget Office and independent experts. But Senate Republicans, who have blocked legislation to extend unemployment benefits, continued to portray the administration as fiscally reckless and the stimulus as ineffective.

"I know what they’re against, but I don’t know what they’re for," Vice President Joseph R. Biden Jr. said of the Republicans as he unveiled the report. "I mean that literally."

With Congress deadlocked over fiscal policy, attention has shifted to monetary policy as a tool for attacking the 9.5 percent unemployment rate. But on that score, the Fed is also divided, although its disagreements are expressed in a more genteel manner.

On Wednesday, the Fed lowered its estimate of economic growth for this year, to a range of 3 percent to 3.5 percent, from the 3.2 percent to 3.7 percent forecast in April. Inflation has been running well below the Fed’s unofficial target of nearly 2 percent, so much so that a few officials fear that the United States is at risk of the kind of deflationary spiral that has hobbled the Japanese economy for the better part of two decades.

The Fed’s chairman, Ben S. Bernanke, has not embraced that view, but even those who disagree with it say the Fed, whose modern institutional culture was built around fighting inflation, now confronts a distinctly different problem of high joblessness.

"If federal fiscal policy is approaching its political or economic limits, some believe that the Federal Reserve should do more, including expansion of its balance sheet," Kevin M. Warsh, a Fed governor who is close to Bernanke, said in a recent speech to the Atlanta Rotary Club. "In my view, any judgment to expand the balance sheet further," by acquiring mortgage bonds and debt, "should be subject to strict scrutiny."

The central bank has already held interest rates lower for longer than at any time since the Great Depression, keeping the benchmark short-term interest rate near zero since December 2008. Since the start of the financial crisis, the Fed has more than doubled its balance sheet, to $2.3 trillion, by buying mortgage bonds and Treasury debt to keep long-term interest rates low.

But, as Bernanke pointed out in a speech in 2002, when he was a Fed governor, a central bank that has run out of ordinary tools to prop up the economy, like lowering short-term interest rates, still has other options to prevent deflation.

By resuming its purchases of assets or by being more explicit about its intentions to keep interest rates low, the Fed could lower inflation expectations and long-term interest rates. That could further stimulate borrowing and spending by companies and individuals.

The minutes released Wednesday from the June 22-23 meeting of the Federal Open Market Committee, the Fed’s crucial policy body, cited the threat of deflation in the United States for the first time in a year.

"A few participants cited some risk of deflation," the minutes noted. "Other participants, however, thought that inflation was unlikely to fall appreciably further, given the stability of inflation expectations in recent years and very accommodative monetary policy."

The minutes, which are carefully worded to avoid the appearance of discord, nonetheless made clear a growing divergence in views.

"Several participants noted that a continuation of lower-than-expected inflation and high unemployment could eventually lead to a downward movement in inflation expectations that would reinforce disinflationary pressure," the minutes stated. "By contrast, a few participants noted the possibility that a potentially unsustainable fiscal position and the size of the Federal Reserve’s balance sheet could boost inflation expectations and actual inflation over time."

The direction of monetary policy will probably be raised at a hearing Thursday, at which the Senate Banking Committee will take up the nominations of Janet L. Yellen, president of the Federal Reserve Bank of San Francisco; Peter A. Diamond, an economist; and Sarah Bloom Raskin, a banking regulator, to seats on the Fed’s seven-member board of governors.

While the Fed debate continues, the White House is combating skepticism over the $787 billion stimulus program.

In the latest CBS News poll, almost three-quarters of Americans said the stimulus had not improved the economy. A new poll by The Washington Post and ABC also found that more than half of respondents said the government should not provide additional stimulus.

"More debt only subtracts capital from the private markets that could be used for loans, to hire more people and create more jobs," Sen. Lamar Alexander of Tennessee, the chairman of the Senate Republican Conference, said in an interview.

He said the administration’s proposals on health care, regulation, energy and trade had discouraged private-sector growth.

To shore up support for the stimulus program, the White House has been promoting what Biden has called the "summer of recovery."

The new report, by the Council of Economic Advisers, showed that the pace of fiscal stimulus had accelerated, with spending growing to $116 billion in the second quarter from $108 billion in the first quarter and $80 billion in the final three months of 2009.

The report also estimated that gross domestic product, a measure of overall economic output, was 2.7 percent to 3.2 percent higher than it would have been without the stimulus.

"I am absolutely confident we are moving in the right direction, absolutely confident," Biden said.

He said federal money had been be used to stimulate emerging industries like clean energy.

"None of this would have been possible if our friends on the other side — as my mother would say, God love them — our friends on the other side had gotten their way," Biden said.

The report used historical data and statistical modeling to arrive at the estimate of jobs saved or created, but Christina D. Romer, chairwoman of the Council of Economic Advisers, acknowledged that there was some uncertainty over the job estimates, which rely on reporting from recipients of federal aid.

"I suspect the true effects of the act will not be fully analyzed or fully appreciated for many years," she said, adding that most experts agreed that the stimulus had had a "significant, beneficial impact on employment and output over the past year."

Biden acknowledged public frustration over the economy but noted that the crisis predated the administration. "Before we walked in the West Wing, we were handed a deficit, a bill for that year, for over $1 trillion," he said.

Real GDP started growing in the second half of last year, and private sector payrolls have increased by nearly 600,000 since their low point in December. But that has been barely enough to keep pace with the normal rate of growth of the work force.


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