Bullard Challenges Fed to Respond To Weakening Inflation

By Steve Matthews and Rich Miller

Federal Reserve Bank of St. Louis President James Bullard challenged his fellow central bankers to honor pledges to adjust bond purchases in response to incoming economic reports and to keep inflation stable.
Bullard said the Fed should consider delaying plans to end its bond-buying program at the end of this month to halt a decline in expected inflation. The Fed has tapered purchases to $15 billion a month from $85 billion in December 2012.
“We said the taper was data dependent,” he said in an interview today in Washington. The Fed’s message should be that “we are watching and we’re ready and we are willing to do things to defend our inflation target.”
Bullard’s comments reflect growing concern among Fed policy makers that global economic weakness threatens to push inflation in the U.S. to
dangerously low levels. His worries may be reflected in the Fed’s next policy statement, even if his proposal to extend asset purchases isn’t adopted, said Jonathan Wright, a former central bank official.
“The statement is going to dial back on the inflation language to express more concern about consistent undershooting on inflation,” said Wright, who worked at the Fed’s division of monetary affairs from 2004 until 2008 and now teaches economics at Johns Hopkins University in Baltimore.
Bullard, who helped lay the intellectual groundwork for the Fed’s quantitative easing program, is the first Fed official to publicly suggest the central bank should extend asset-buying when policy makers meet later this month.

Stocks, Treasuries

U.S. stocks erased losses and Treasury yields rose on expectations the Fed will take action to insulate the U.S. from global economic weakness. The Standard & Poor’s 500 Index gained less than 0.1 percent at 4 p.m. in New York after dropping as much as 1.5 percent. The yield on the 10-year Treasury note rose two basis points, or 0.02 percentage point, to 2.16 percent.
The Fed, which cut interest rates to near zero in December 2008, said last month that asset purchases would probably end after its next meeting, on Oct. 28-29, and reiterated that rates would remain on hold for a “considerable time” after the program ends.
“Ending the asset purchases has been baked in the cake for quite a while,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.
Policy makers, including regional Fed Presidents William C. Dudley of New York, Charles Evans of Chicago and Narayana Kocherlakota of Minneapolis, have in recent days mentioned below-target inflation as a risk that weighs against raising interest rates too soon.

‘Not Alone’

“Bullard is not alone” in his concern, said Mark Vitner, senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “They may shift the discussion to what do they do in regard to forward guidance on interest rates.”
“Bullard is a very practical voice at the Fed, and changes in his views often reflect the swing in the balance of risks in the economy,” Vitner said.
Bullard has said that a decline in inflation hurts the Fed’s credibility and could risk an outright fall in prices, which can result in a “deflationary spiral.”
Economists say deflation can encourage households to delay spending in the hope that prices will fall further, sapping demand and undermining growth. Determination to avoid that self-reinforcing trap spurred the Fed to announce successive rounds of bond purchases, known as quantitative easing, or QE.

Falling Short

Inflation tied to consumer spending, the Fed’s preferred measure, rose 1.5 percent in the year ended August, compared with the central bank’s target of 2 percent. Price rises have fallen short of that target for 28 consecutive months.
Bullard, 53, said he was particularly concerned with market measures of expected inflation, with one such measure showing the outlook for price gains averaging less than 1.5 percent over the next five years.
“Inflation expectations are declining in the U.S.,” he said. “That’s an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.”
Preserving the program would allow the Fed to adjust the pace of purchases if necessary, Bullard said. “We could react with more QE if we wanted to,” he said.
Bullard, who doesn’t vote on policy until 2016, has been seen as a bellwether because his views have sometimes foreshadowed policy changes.

2010 Paper

He published a paper in 2010 entitled “Seven Faces of the Peril,” which called on the central bank to avert deflation by purchasing Treasury notes. That was followed by a second round of bond buying.
For several years he has argued that bond purchases should be “state contingent,” with small adjustments made in response to economic data, just as the Fed would make quarter-point interest-rate moves in normal times.
Still, “the Fed has been itching to end QE sooner rather than later,” said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. He said maintaining QE would be an option only “if the financial markets continue to head south, if the global economy continues to deteriorate.”
The Fed’s concern over expectations may be muted by considering a wider range of measures, including consumer and business surveys, Crandall said.

Consistent Movement

“The Fed has got a very layered view of inflation expectations,” he said. “In order for you to believe that inflation expectations have become unanchored, you need to see a consistent movement across all the measures.”
Moreover, the central bank may hesitate to be seen as reacting to financial-market turmoil, said Carl Tannenbaum, chief economist at Northern Trust Corp. in Chicago, who formerly worked at the Chicago Fed.
“You don’t want monetary policy whipsawed by short-term movements,” he said. “It is far too early to be calling for an important change in monetary strategy” based on “seven days of market trading.”