* U.S. cannot ease debt burden by "surprise" inflation -
* Says investors signal they think Fed may allow inflation
above 2 pct
* Inflation would impose costs on savers, higher interest
rates in future
By Alister Bull
MEMPHIS, Oct 4 The United States faces a debt
problem, but any suggestion that the burden can be eased by
allowing inflation to rise will just result in higher borrowing
costs in the future, a senior Federal Reserve official said on
James Bullard, president of the Federal Reserve Bank of St.
Louis, said that inflation was sometimes seen as a way to
"partially default" on existing debts, because it lowers the
amount the borrower repays in real, inflation-adjusted terms.
"A partial default today through higher inflation would be
paid for via higher inflation premiums in future borrowing.
Creditors would want to protect themselves against an
unpredictable central bank," he told the Economic Club of
"Alas, in economics there is no free lunch," he said,
quoting Nobel Prize-winning economist Milton Friedman.
Bullard is not a voting member of the Fed's policy-setting
committee this year, but will hold a rotating vote in 2013.
"Is this happening? Distant inflation expectations from the
TIPS (Treasury inflation protected securities) market seem to
suggest that investors do not completely trust the Fed to
deliver on its 2 percent inflation target," he said.
The U.S. has been slowly recovering from the deep 2007-2009
recession, which was caused by a collapse of the housing market
that triggered a devastating global financial crisis.
Many U.S. households were left owing more on their homes
than the properties were worth. At the same time, the U.S.
government has aggressively expanded spending to shield the
country from an even deeper downturn, widening the deficit and
driving up national debt.
Bullard has publicly stated that he would not have voted for
the Fed's third round of so-called quantitative easing announced
at its policy meeting last month, at which it also committed to
holding interest rates near zero until at least mid-2015.
The Fed also promised that it would keep rates ultra-low
even as the economy strengthened, in order to ensure that
stubbornly high U.S. unemployment was brought back to more
normal levels, so long as inflation remained under control.
The national unemployment rate was 8.1 percent in August.
The Labor Department will release the September employment
report on Friday.
Bullard said that any effort to inflate away the debt
problem would impose severe costs on the people who had lent the
money, or on those who lived on fixed incomes.
SAVERS AND CREDITORS
"The partial default would occur against savers, mostly
older U.S. households, and against foreign creditors," he said.
Fed critics say that its $2.3 trillion purchases of
Treasuries and mortgage-backed bonds, plus September's decision
to buy another $40 billion of mortgage-backed securities every
month until hiring picks up, will severely sap the value of the
Fed activism has also been caught up in the U.S.
presidential election, turning the central bank into a lighting
rod for critics of big government who complain 'Washington' is
intruding too far into the private sector's space.
Bullard, whose Federal Reserve district embraces states in
heartland America far from both coasts, acknowledged public
concern about "what the heck is going to happen next" that could
harm confidence in the central bank.
"I would very much like to get out of the kind of crisis
mode that we've been in. You know, after four years it is not a
crisis any more. (We've) had plenty of chance to adjust at that
point," Bullard told the audience during a question-and-answer
Minutes of the FOMC's September meeting released earlier on
Thursday also showed that many committee members favor a
commitment to lower the jobless rate beneath a certain level
before raising interest rates, in order to better communicate
its determination to bolster U.S. growth.
However, making clear this vision was not without
opposition, Bullard said he had problems with that approach.
"I think we should be very cautious about tying monetary
policy explicitly to the unemployment rate," he told reporters
on the sidelines of the dinner event, warning that the Fed could
find itself in a policy "box" with such an approach.