The U.S. Federal Reserve risks pushing inflation even lower if it tapers bond purchases too aggressively and could take a more cautious approach by initially only scaling back by a small amount, a senior central banker said on Wednesday.
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James Bullard, president of the St. Louis Fed, said he had not yet made up his mind if next month's Fed policy meeting would be too soon to start curbing bond buying, as markets currently expect, but he was aware of the risks of being too aggressive.
"It is possible if you pull back too quickly you put more downward pressure on inflation and end up with inflation running below 1 percent. And then I think at that point, deflation possibilities would start to arise," he told reporters after delivering two speeches in this port city on the Ohio River.
"We're not in that situation right now, but that is one scenario that I would worry about," he said.
Deflation is considered a risk to economic growth because falling prices tend to cause both businesses and consumers to delay purchases in expectations that prices will fall even further.
Inflation measured by the PCE price index, the Fed's preferred gauge, is around half the level of the U.S. central bank's 2 percent target. The Fed nodded in July to the risks that prolonged low price pressures would pose for the economy.
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"There has not been much indication, so far, that it has been ticking back up toward target," Bullard said.
The central bank has said it will likely start to reduce its bond purchases from the current level of $85 billion per month later this year, provided the economy picks up as expected, and end the program around mid-2014 when it expects U.S. unemployment to have fallen to around 7 percent. The jobless rate was 7.4 percent in July.
Bullard suggested the Fed could exercise caution by cutting back by only a modest amount.
"There are a lot of ways this could go. You could do a small amount of tapering versus a larger amount," he said.
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Ideally, the central bank will have more data to digest on the progress of the economy before making a decision, Bullard said, but he acknowledged that there were only a few weeks left before the next policy meeting, on Sept. 17-18.
Bullard, however, expressed frustration that investors' attention has focused on the September and December policy meetings, because they will be followed by press conferences with the Fed chairman. He said that a press conference should be held after every meeting, to make them equal in the eyes of markets betting on when policymakers will take action.
"Not having a press conference in October, is that really taking it off the table, that you can't delay if you wanted to delay?" he said. "Why is the committee allowing that to shape the decision-taking process?"
In considering whether to cut back on bond-buying, Bullard said the Fed would review developments in the labor market, where unemployment has fallen since the current bond purchase campaign began last September.
"I would be happy to claim that there has been substantial improvement in labor markets. I think the bigger question marks are on growth and on inflation," he told reporters.
The Fed's "committee has set a target. They've set it at 2 percent," Bullard said. "Once you've set it, you had better have some credibility that you are going to hit it."
Bullard, a voting member of the committee this year, dissented at the June meeting, saying that the Fed should have signaled more strongly its willingness to keep its stimulus in place out of concern inflation was not heading higher.
Bullard has been particularly outspoken on the issue, and released an unusually sharp statement to explain his dissent, although he voted with the majority at the July meeting after the inclusion of a low inflation warning in the statement.
Other officials have also said that they want assurance that low inflation is indeed transitory, as their forecasts predict.
(Reporting By Alister Bull; Editing by Leslie Adler)