I have argued in the past (for example here, here, and here) that there is no need at all to be concerned about deflation – most certainly not in monetary policy, secondarily not in commonly measured CPI, and likely not again in asset prices. The Fed will inflate until commonly measured CPI reaches politically unacceptable levels – double digits at least, I suspect.
The Fed will inflate at any time there is any risk of commonly measured price deflation. The Fed will buy any asset necessary to meet its objectives. Every hint of credit contraction will be met with more-than-offsetting inflationary policies. At least until the pain threshold of consumer prices ends the game.
In a blog post at the Peterson Institute, Joseph Gagnon makes my point. In arguing against the possibility of a “liquidity trap,” Gagnon suggests:
The liquidity trap hypothesis has some validity, but only if one arbitrarily restricts the definition of monetary policy to purchases of short-term risk-free bonds. There is no economic reason, and not even a historical precedent, for such a limited view of monetary policy.
Unlike Bernanke, Gagnon has no qualms about properly labeling central bank operations: “Monetary policy consists of printing money to buy assets.”
Central banks can buy anything, as necessary to support monetary policy:
Central banks have always held risky assets, including long-term bonds, loans to banks, gold, and foreign exchange reserves. Some central banks also hold equity and real estate….There is no reason to doubt that central bank purchases of equity or real estate could significantly influence the prices of those assets.
There is no limit in quantity, quality, or type of assets purchase: auto industry needs a jolt, buy up auto loans; colleges lack funding, buy up student loans; municipal government bonds lacking support…well, you get the idea.
The only question is why the major advanced-economy central banks have been so timid in using their powers and allowed inflation—and for the United States, employment—to fall below their targets.
“Timid” is not the word I would use to describe balance sheets that have tripled in just a few, short years. Nevertheless, his point is well-taken: central banks will buy whatever they need to buy, whenever there is a hint of deflation.
Until consumer price inflation wins. That’s when things will become really interesting.