Unconventional: A Policymaker's Reflections on Crisis to Recovery
"In 2010, measures of core inflation were low and declining in the U.S. Jim Bullard became greatly concerned about this trend and the risks of ending up in a deflationary trap as Japan did. With the FOMC's policy rate already near zero, he argued for additional quantitative easing, or QE, to avoid deflation. To help make his case, he released his influential 'Seven Faces of "The Peril"' paper in July of that year. The FOMC began QE2 in November 2010."
—Cletus Coughlin, Senior Vice President and Chief of Staff to the President
James Bullard shared some reflections on his first 10 years as Bank president during recent conversations with staff. The following are excerpts from those discussions.
The Great Recession officially ended in June 2009, and the economy began to recover slowly. Positive real GDP growth resumed, while payroll employment losses slowed down and eventually turned into gains. Inflation, however, was a different story.
By a variety of measures, inflation not only was low but was declining in 2010. Some measures of core inflation even dipped below 1 percent in 2010. In my view, some people at the FOMC meetings did not seem overly concerned about the immediate U.S. inflation situation. But, the disinflationary trend didn’t look good from my perspective. I highlighted it in a paper called "Seven Faces of ‘The Peril,'" which was initially released in late July 2010.
In early 2010, inflation was close to the Fed’s then-implicit inflation target of 2 percent. But a disinflation trend developed that year, sending some measures of core inflation below 1 percent. Note that this figure combines series from two different figures in Bullard's presentation on Nov. 8, 2010.
SOURCES: Bureau of Economic Analysis, Federal Reserve Bank of Dallas and Bureau of Labor Statistics.
In the paper, I compared what had happened in Japan with what was happening in the United States. Japan, which is a big, industrial economy similar to the U.S., had been battling deflation for more than a decade at that point. Basically, Japan was stuck in a long-run outcome of low nominal interest rates and deflation.1 The general attitude in the U.S. seemed to be that there was something special about Japan and that the Japanese-style outcome couldn’t happen here. However, I didn’t really think that was the case.
The paper included a theoretical explanation for why we could possibly get stuck in the same situation as Japan—namely, that the FOMC’s promise to keep the policy rate near zero for an "extended period" may be counterproductive and may encourage the undesired long-run outcome. The conclusion was that, among the options available to the FOMC, the best course of action for turning inflation around was to implement QE. Thus, I was a big advocate of beginning a QE2 program.
In my opinion, the release of that paper and my CNBC interview the next day ignited a lot of the fire around QE2. For example, the talk in financial markets of a possible QE2 program accelerated. In addition, Chairman Bernanke gave a speech in Jackson Hole, Wyo., in August that was interpreted as being more sympathetic to the possibility of QE2 than his previous remarks. According to financial markets, the probability that the FOMC would go ahead with a new QE program essentially went from zero percent in July 2010 to 100 percent in early November, which is when the FOMC decided to implement the program. (QE2 consisted of purchasing $600 billion of longer-term Treasury securities from November 2010 through June 2011.)
Was QE2 successful? Because of the forward-looking nature of financial markets, the financial market effects mostly occurred between late July and early November and were in the expected direction. Equity prices rose, the dollar depreciated dramatically, longer-term interest rates fell, and inflation expectations rose. Actual inflation also turned around and increased during 2011. By January 2012, headline inflation was above the Fed’s 2 percent target, and core inflation was right at target. Based on these results, I thought QE2 was very successful at that point.
Although the financial market effects were as expected, there was also an expectation that real GDP growth would pick up. People thought that the financial market effects would, in turn, lead to improvement in the real economy (such as increased household consumption, export activity and investment activity). However, that never happened. Slower real GDP growth has persisted over the past several years, with the U.S. averaging about 2 percent growth since the financial crisis.2