The Federal Reserve Seems to Underestimate the Threat of Deflation

Federal Reserve Chairman Ben Bernanke has suggested that an inflation rate of 2% is ideal.

In his June 19 press conference, Bernanke said progress toward that inflation goal is a key factor in how fast the Fed will unwind its bond purchase program. The Fed could start to cut back on its bond purchases as early as the end of 2013.

But a June 21 Marketwatch article mentions that "the Fed has been consistently wrong about hitting its inflation target of 2%. The Federal Open Market Committee's central tendency forecast for inflation in 2013 have been revised lower and lower, meeting after meeting, and now stands at a range of 0.8% to 1.2%."

The title of the article is "Bernanke doesn't fear deflation -- but should."

Here's an excerpt:

The trimmed mean PCE index (which is an alternative way of looking at underlying inflation trends that doesn't automatically exclude food and energy) fell 0.1% in April. That was its first decline ever.

Inflation expectations are also low and falling. The spread between regular 10-year Treasurys and inflation-protected Treasurys (TIPS) has narrowed. The Cleveland Fed's analysis shows expected inflation below 2% for the next 30 years. Professional forecasters also expect low inflation to continue.

Is Bernanke correct to believe that inflation rates won't fall further? At least one of his colleagues, James Bullard of the St. Louis Federal Reserve Bank, isn't convinced. Bullard voted against the FOMC's statement on [June 19] because he 'believed that the committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings' and issued a statement [June 21] indicating he had dissented because of a concern about low-inflation risks.

Bernanke was asked at his press conference specifically about Bullard's perspective: 'Does this sort of inflation performance suggest that you should be pushing harder on the accelerator?'

Bernanke hemmed and hawed. He agreed that low inflation is terrible. 'It increases the risk of deflation. It raises real interest rates. It means that debt deleveraging takes place more slowly.'

To read the entire article, click here.