By Steve Matthews and Kathleen Hays
Dec. 2 (Bloomberg) -- The Federal Reserve may provoke deflation by cutting the main interest rate, and policy makers should consider relying on other tools to revive the economy, St. Louis Fed President James Bullard said.
“I’m more concerned at these very low levels about the Japanese outcome” last decade, Bullard said today in an interview, while noting that deflation isn’t an immediate threat. Japan’s central bank “went to zero” with its main interest rate, and “deflation becomes a self-fulfilling thing and you are stuck at zero.”
Fed policy makers, confronting what may be the worst recession since World War II, will reduce the target interest rate at a Dec. 16 meeting by a quarter-point to 0.75 percent, according to economists surveyed by Bloomberg News. While Bullard himself may not support another cut, he said the Fed is debating how to use its other policy tools and communicate its intentions.
The central bank may ultimately reduce the target rate to zero percent, according to economists at Macroeconomic Advisers LLC, JPMorgan Chase & Co. and HSBC Securities USA Inc. Macroeconomic Advisers on Nov. 24 predicted the Fed may reach zero in January and will also consider unconventional policy actions, including purchasing private assets.
“I have not been a fan to going to really low levels,” Bullard said in an earlier Bloomberg Television interview. “Why is it zero this time? I don’t quite get that, though I know some people want to go in that direction.”
Policy ‘Limits’
“There are limits of what you can do with interest rate policy,” he said. “We have a market conditioned to think of interest rates as the definition of monetary policy.”
Policy makers are discussing how to pursue a policy of quantitative easing, or adding more than enough reserves to keep rates close to zero, Bullard said. “The Fed is wrestling with that right now.”
Bullard said he wasn’t ready to endorse any specific ideas, adding he was studying the issue and new policies would raise difficult issues of how any new twists should be communicated.
Fed Chairman Ben S. Bernanke said yesterday he has “obviously limited” room to lower interest rates further and may use less conventional policies, such as buying Treasury securities, to revive the economy.
The U.S. economy “will probably remain weak for a time,” Bernanke said in a speech in Austin, Texas. While the Fed can’t push interest rates below zero, “the second arrow in the Federal Reserve’s quiver -- the provision of liquidity --remains effective,” he said.
Emergency Programs
The central bank announced today it extended the term of three emergency programs with about $304 billion in total loans outstanding to calm financial markets amid the most severe credit crisis in seven decades. The programs, originally set to end on Jan. 30, will run until April 30.
Bullard said he sees a “more V-shaped” recovery next year, with a “quicker” rebound by consumers from the recession, than many private forecasters. Unemployment may peak at 7.5 percent to 8 percent, he said, a level similar to the 1991 slump.
“I was surprised by the number of retail sales over the holiday weekend,” Bullard said. “Even if they are buying low- priced stuff, I was impressed it was bigger than last year.”
Home prices are also near their fundamental value and will probably bottom out next year, helping to stabilize the economy, he said. “There is no bubble anymore in housing prices.”
Economy To Shrink
Fed policy makers predicted the U.S. economy will shrink until the middle of next year, with some officials concerned about the risks of deflation, according to minutes of the Oct. 28-29 meeting. Fed policy makers cut the benchmark interest rate to 1 percent at the gathering.
Bullard took over as president from William Poole, who retired on March 31. He won’t vote this year on interest rates on the Federal Open Market Committee and his turn in the rotation among Fed bank presidents will be in 2010.
Consumer prices excluding food and fuel costs fell in October for the first time since 1982, according to government figures. The consumer price index plunged 1 percent in October, the most since records began in 1947, the Labor Department said.
Bullard, noting that prices are rising on a year-over-year basis, said he doesn’t share the concern of some economists about deflation in the immediate future.
“It would take a lot to drive that down to deflationary levels,” he said.
Meanwhile, “inflation expectations are fanning out,” Bullard said. “There are some people thinking that there might be a lot of inflation,” while others see a chance of deflation, he said.
The Fed must “control both sides of that,” he said.
The Fed has reduced its benchmark rate by 4.25 percentage points since September 2007, to 1 percent, and rescued Bear Stearns Cos. and American International Group Inc. from failure with emergency loans.
To contact the reporter on this story: Steve Matthews at smatthews@bloomberg.net; Kathleen Hays in New York at Khays4@bloomberg.net.
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