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How worried is the Fed about deflation?

By Greg McBride, CFA · Bankrate.com
Tuesday, September 21, 2010
Posted: 5 pm ET

The Federal Open Market Committee's statement issued this afternoon clearly conveyed a willingness to throw more money into the financial system with another round of quantitative easing, perhaps as soon as November. That is what the market expected from the Fed, and the Fed delivered.

But what is most significant -- and somewhat alarming -- is that the Fed inserted three comments about inflation that is too low for their comfort level.

The first: "Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability."

Second: " ... inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate."

And third: " ... is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate."

That makes three references, and that is three more than were in the Fed's August statement. The criteria many consider to be key in the Federal Reserve's decision to return to quantitative easing and attempt to drive interest rates lower is the unemployment rate. I'd add the Consumer Price Index and any other inflation readings to that.

While the effectiveness of any additional moves on the pace of economic growth and the appetite for mortgages and home purchases is up for debate, what isn't is the willingness of the Fed to act to ward off any hint of deflation. It may not take deterioration in the economy, but a lack of movement in price levels that ultimately gets Ben Bernanke to restart the money printing.

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5 Comments
Barak Volner
September 23, 2010 at 12:57 am

Increasing the supply of money may not be such a bad idea at this point given the markets' reaction to what we have recently experienced. Quantitative easing will allow the bond market to keep going up, the dollar may weaken which will prop up certain commodities such as gold. The downside on the treasury yields still lingers. How long will foreign investors will be purchasing US debt now that no recent policies have been changed?.Both sides have good arguments, still only opinions.