Roubini: The Fed Needs to Fight Deflation and a Double Dip Recession
Published: Thursday, 11 Nov 2010 | 1:21 PM ET Text Size
By: Ash Bennington

With all the second guessing of QE2 — and even chatter about a return to a gold standard—Nouriel Roubini is very clear about the primary challenge to the U.S. economy: "The risk is deflation—not inflation."
Roubini, of course, has been on record supporting quantitative easing for some time. But, in my interview with him, he made clear that he's still not sanguine about growth prospects—even after the injection of a fresh $600 billion.
What value does he see in QE2 (Federal Reserve easing quantitative easing)? Principally, he believes it's a necessary evil for allowing the U.S. economy to steer clear of catastrophe.

"It certainly reduces the tail risk of a double dip [recession]," he said."And it reduces the risk of outright deflation or the expectation of deflation."

In our discussion, Roubini made his case against the critics of quantitative easing very clear—and explained the dire consequences of inaction.

"The biggest problem we're facing today is growth that is too low. And inflation that is too low. And if we don't do anything to prevent growth that is too low…then we're going to end up in deflation," Roubini said And how bad might that get? According to Roubini, if the deflation scenario is allowed to unfold due to an absence of central bank intervention, "we end up like Japan: In a trap of near depression that can last a decade—if not longer."

But what of inflation? Aren't there risks inherent in expanding the money supply? Haven't we witnessed the disastrous consequences around the world when governments recklessly run the monetary printing presses?

Roubini is very clear about why the nightmarish inflation scenario isn't likely to occur now in The United States.

To begin with, there is slack in the labor market. And that 'slack' is broader than the unemployment statistics alone would suggest. To more fully understand the employment situation, you need to account for not just the unemployed, but the underemployed, discouraged workers, and 'overstaffing' which, in part, is driving corporate profits without top line growth.

Roubini points out: "As long as there is slack, you can actually grow many years above trend before you see tightness in the labor markets and goods markets,"—which is what he says drives inflation in the first place.

When I asked Roubini if politicians who advocate anti-Fed policies—such as the abolition of the Federal Reserve Board—should be addressed, he said: "Some of the stuff they say is so weird that I don't even know if it's worth engaging them or not."

But Roubini acknowledged that those who say that QE2 is going to cause massive debasement of the currency must be engaged. And Roubini understands the linkage among the ideologies of that political movement: "That's also the argument for the gold standard," he said in reference to the connection drawn in some sectors.

Essentially, opposition to fiat money generally—and QE2 specifically—always sees an inflationary bias and the government creation of money as problematic. Hence, the desire for the gold standard and other fixed rate regimes. But according to Roubini, "Those kinds of arguments are totally senseless today."

Some among the camp who oppose QE2—and many of the Fed abolitionists—have a desire to "tie the hands of policymakers," as Roubini says.

But, in these economic times, that's not just undesirable—it's downright dangerous.

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