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November
27, 2002, 8:30 a.m. |
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n
recent appearances, Federal Reserve Chairman Alan Greenspan and Fed Governor
Ben Bernanke outlined their explanation of deflation and the power of
central banks to stop it. This is an important development as it fills
a void in the economic-policy outlook.
Here's the welcome sequence of events:
On November 13, Greenspan testified to Congress's Joint Economic Committee, concluding that "we are not close to a deflationary cliff. If we ever get to that point, remember we are not limited with respect to purchasing only assets which affect the overnight federal funds rate."
On November 19, in answer to questions at the Council of Foreign Relations, Greenspan expanded on his JEC answer: "We are very far from the Fed being restricted. We would just move out on the curve, as we have done in the past."
Then, on November 21, Fed Governor Bernanke gave an 11-page speech elaborating in detail on several of Greenspan's CFR comments. In the speech he said, "I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief." (The full text can be found at www.federalreserve.gov).
What this means is that the Fed is presenting a coordinated, new message aimed at dispelling deflation uncertainties. Given the stage of the recovery, the level of the dollar, and the forcefulness of the new anti-deflation direction, the message is a big step forward.
It means the Fed is prepared to cut interest rates further in the (unlikely) event the economy slows, unemployment rises sharply, or inflation moves toward zero. More, the Fed doesn't think it is running out of ammo or needs to save its rate cuts, and it will now be able to correct the deflation expectations in the markets. This should lead to less risk-averse investment and inventory decisions.
In recent months, there have been numerous predictions of a new deflation and articles about the Fed struggling to find ways to stop deflation. But Greenspan and Bernanke are right that the risk of a deeper deflation is low and that the Fed has powerful tools to prevent it.
The Greenspan and Bernanke comments, in combination with the ongoing stabilization of the dollar, have set the right direction for sustaining the recovery in the U.S. This new message should work relatively quickly to improve the economic outlook by reducing risk aversion and encouraging business and inventory investments.
— Mr. Malpass is the Chief International Economist for Bear Stearns.