`Reflation' Comes Into Focus as U.S. Struggles to Battle Deflation
INFLATION. DEFLATION. Disinflation. The economic lexicon is garbled with so many 'flations these days, it's getting a little hard to make sense of them all. During the 1970s, '80s and '90s, Washington policy makers waged a persistent battle against inflation, broadly defined as rising consumer prices. But for most of this year, as the inflation rate has fallen closer to zero, economists began to worry about the opposite trend -- the possibility that the U.S. could face Japan-style deflation, or falling consumer prices.</br></br>As we enter 2003, here comes a new watchword: reflation. The term refers to government efforts to pump up -- or reflate -- an economy that is stuck in a slump by flooding that economy with money. Essentially, reflation is the intentional effort by governments to ward off deflation by boosting demand and underpinning prices. Though it isn't quite the same as inflation, reflation can spark inflation problems if policy makers go too far.</br></br>The term is popping up often. In a recent report titled "The Reflation Trade," Morgan Stanley Co. chief economist Stephen Roach argued that policy makers are now in a "full-scale frontal assault on the perils of deflation." That has made him more bullish on the stock market in the months ahead. James Grant, in his twice-monthly newsletter, Grant's Interest Rate Observer, writes about a "global reflation program" being led by the U.S. and spreading world-wide. That, he said, explains why prices for gold -- a hedge against inflation and his favorite investment -- are on the rise.</br></br>SOME ECONOMISTS who have been beating deflation drums are doing an about-face. "There has been an important shift. The financial community is talking more about reflation . . . it is the thing to watch in 2003," says Paul McCulley, chief economist at Pacific Investment Management Co., the California bond-fund manager that recently advised clients that government-bond yields will rise as result of today's reflation tilt.</br></br>Behind the reflation focus is blunt talk by Federal Reserve officials. Earlier this month, Fed Chairman Alan Greenspan told economists in New York that while deflation is only a remote possibility, the central bank is "extraordinarily sensitive" to the potential perils associated with it and is prepared to forestall it if the economy moves further in that direction. In November, Fed governor Ben Bernanke laid out a series of unusual steps the Fed could take to get out of Japan-style deflation if it did happen -- such as lending more aggressively to banks to drive down private borrowing costs or buying foreign government bonds, which could weaken the dollar and boost exports.