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By Jeremy Glaser | 11-03-2010 05:08 PM

The Fed's Punch Bowl Problem

Though its current deflation-fighting actions are valuable, charting a successful exit plan will be difficult, says former Fed governor and economics professor Randy Kroszner.

Jeremy Glaser: From Morningstar.com, I'm Jeremy Glaser. I am here today at the 2010 Morningstar Stocks Forum. I am pleased to be joined with Randy Kroszner, who is a former governor of the Federal Reserve, and is now an economics professor at the Chicago Booth School of Business.

Randy, thanks so much for taking the time today.

Randy Kroszner: Delighted.

Glaser: So, Ben Bernanke finally opened up his toolbox and said that he's going to be bringing out $600 billion of new bond purchases, or quantitative easing, that we've been talking about for so long. Why is the Fed making this move?

Kroszner: I think, it's really important that they are to really buy some insurance against a very bad outcome, that outcome being deflation. You can get into a situation, like we got in the 1930s, or that Japan has gotten into, that if you actually have the price levels start to fall, you have very big debt burdens on people, you have people waiting to make purchases because they see prices are going to go down in the future. You get into a very difficult deflation spiral, hard to get out of it. So I think, it's very important that the Fed is trying to provide some support right now.

Glaser: This is something they've been talking about for a long time. Do you think it's going to be effective?

Kroszner: I think, it's already been effective. What I sometimes call the types of things that they're doing are open-mouth operations, rather than open-market operations, because they're trying to affect expectations, but what the Fed will do, is it really committed to fighting deflation? This is one of the problems with the Bank of Japan. They are very slow to respond to the declining inflation rate, and even when they got to deflation, they were still very slow to respond, and once you get stuck down there it's hard to get out. The Fed is trying to be proactive, make sure we don't get into that situation, and I think that's really valuable.

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