- The Washington Times - Tuesday, May 13, 2003

For good reasons, central bankers are generally loath to broach the subject of deflation in public. Deflation represents a decline in the general price level; merely addressing the subject carries the risk of inducing consumers to reduce their current spending in anticipation of lower prices in the future. When the economy is already weak, the risks intensify.

The fact that Federal Reserve Chairman Alan Greenspan assuredly understands this dilemma makes his recent congressional testimony and the Fed’s statement following its last monetary-policy meeting all the more remarkable. Without being prompted by questioning at his April 30 testimony before the House Committee on Financial Services, Mr. Greenspan concluded his prepared remarks with this cryptic warning: “With price inflation already at a low level, substantial further disinflation would be an unwelcome development, especially to the extent it put pressure on profit margins and impeded the revival of business spending.”

In an unprecedented development a week later, the Fed formally acknowledged the danger of deflation in its official statement at the close of a meeting of its monetary-policy committee. Since 2000, at the conclusion of each of its eight regularly scheduled meetings each year, the Fed has issued a statement informing the financial markets how it perceives the “balance of risks.” The risks were assessed to be: (1) leaning toward economic growth that was too low, (2) leaning toward inflationary pressures that were too high, or (3) the risks were balanced between the two.

After its May 6 meeting, however, the Fed offered separate assessments of the economy and price pressures. Regarding the economy, it declared that “over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal.” Regarding pricing pressures over the same period, it noted, “[i]n contrast,” that “the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level.”

Aggregating these two assessments, the Fed concluded that “the balance of risks to achieve [the Feds] goals is weighted toward weakness over the foreseeable future.” We could not agree more. Indeed, as we vigorously argued in our Jan. 9 editorial (reprinted below), which explained the insidious effects of deflation and warned about deflation’s incipient approach, expansionary fiscal policy (i.e., tax relief) represents an appropriate, though not necessarily sufficient, response to the threat of deflation. In numerous other editorials, we have entreated the Fed to act pre-emptively by pursuing an increasingly expansionary monetary policy with further reductions of short-term interest rates. Actual expansion of the money supply by Fed purchasing of Treasury notes should also be on the table of policy options.

While the Fed’s official recognition of deflationary forces is welcome, its reluctance to act on this development is regrettable.

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