Is the US economy going down the path of Japan?

When James Bullard comments were first in the press, RPBP posted this Son of Helicopter.  Now, John Hussman's prodigy, Bill Hester, has written the following piece of commentary  The Paradox of the Zero Bound excerpted below.  Is the US going down the path of Japan in a deflationary spiral?  Is the Fed policy of super low interest rates going to backfire and, instead of the desired inflationary effect, have a deflationary effect due to "expectations" (MOPE)?  Well, from an Austrian perspective, the inflation has already occurred - the money has been "printed" it has yet to be leant into existence.  Will it kick in anytime soon, as is the hope of The Father, Helicopter Ben?

With fears of deflation spreading among market participants, it was an auspicious time for a member of the FOMC committee to deliver a paper arguing that the Federal Reserve's current policy was likely to increase the probability of deflation. This was the paper put out earlier this month by James Bullard, the President of the Federal Reserve Bank of St Louis. Much of the focus has been Bullard's comment that the US is closer to a Japanese-style outcome today than at any time in recent history. It's also been highlighted that his preference is for the Fed to buy longer-dated Treasury securities, restarting the type of quantitative easing that it pursued last year...

Another part of Bullard's research paper ( Seven Faces of “The Peril”) that received less attention but was equally interesting was his argument that the Fed's repeated expectation for "rates to stay low for an extended period of time" might actually be increasing the risk of deflation, the very outcome Bernanke is desperately trying to avoid...

In effect, Bullard is saying that a policy that makes a promise to investors that rates will stay low for long periods of time backfires. While the Fed may intend to fan inflation concerns in order to motivate aggregate demand, the private sector begins to assume a semi-permanent state of very little change in inflation, and a growing inability for the Federal Reserve to do anything about it...

On Friday, Kansas City Fed President Thomas Hoenig expanded on the reasons why he has dissented from the current policy in place. “If an attempt to add further fuel to the recovery, a zero interest rate is continued, it is as likely to be a negative as a positive in that it brings its own unintended consequences and uncertainty”, Hoenig said in a speech. “A zero rate after a year of recovery gives legitimacy to questions about the sustainability of the recovery.” While Hoenig believes a deflationary outcome has low odds, his argument is the same. A Zero Bound strategy locks market participants into thinking inflation and growth are not likely near-term outcomes...

Motianey sums up his argument up this way, “Very low nominal rates cannot be used to fight deflation, since they are, in these conditions – the condition of banking system distress – the cause of deflation.” He calls this the Paradox of the Zero Bound. 

Using Japan's experience with deflation, there are a couple of inter-market relationships that may change if the US economy were to fall into a period of sustained deflation. First, the signaling of interest rates would likely change. Typically, falling interest rates support stock prices. Falling rates typically highlight an easing of inflation concerns (especially if real yields remain unchanged), which can be supportive of stock prices. So, typically, bond yields and stock prices move in opposite direction (although this inverse correlation can break down during periods of heightened risk aversion)...

The longer that Japan has kept its policy rate low, and continued to promise to keep rates low, the more persistent and intractable the pattern of deflation has become in Japan. In the US, the risk is not only the detrimental effect to the economy if we enter an “unintended” state, but also the effect that an erosion of the faith in the Fed would have in pricing stocks. The answer to Fed President Bullard's question to policymakers is as equally as important to Bernanke as it is to investors. Will the policy currently in place to protect the economy against slipping into deflation end up being the primary culprit for that same outcome?