Does the Fed Secretly Worry About Deflation?

Whether or not the Fed's action last week was an effort to stimulate the weak U.S. economy is debatable. But few have pointed out that the move might also have another effect, whether intentional or unintentional: it could curb deflation. Might that have been a secret purpose for making sure that the monetary supply wasn't slowly shrinking as mortgage-backed securities paid off more quickly than anticipated? It was likely at least a welcome outcome.

As those securities pay off, the Fed was slowly tightening monetary policy through its inaction. The cash that added to its balance sheet was money exiting the economy. That would work to slow inflation, putting downward pressure on the price level.

Yet, through June, it began to look like a deflationary period could be starting up. At the time of the meeting, the last data they would have reviewed showed consumer prices falling 0.1% in June, while producer prices dropped by 0.5%. Both CPI and PPI had declined for three straight months. Although the Fed didn't indicate in its statement that it was worried about deflation, certainly other economists have been.

Easing monetary policy wouldn't only potentially have simulative effects, but the Fed might also have hoped that it would help to prevent further deflation. Even if this wasn't an explicit end, certainly the central bankers may have appreciated the implicit price stabilization that might result by preventing further declines.

This month, however, we learned that the direction of prices reversed slightly in July. CPI increased by 0.3%, and PPI rose by 0.2%. So some economists might be a little relieved that the price declines didn't continue to mount last month, but this could just be a pause in the trend. The Fed's move, however, might help to ensure that prices begin to rise again more consistently.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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