US ECONOMY IS HEADING FOR JAPANESE STYLE FINANCIAL CRISIS

US is in Danger of Japan-Style Financial Crisis
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This is a dramatic news that would send ripples in the financial markets. According to St. Louis Federal Reserve Bank President James Bullard said on Thursday he is worried about the risks the United States could fall into a Japan-style quagmire of falling prices and investment that is hard to escape.

What could be the best strategy in this scenario. Federal Reserve should consider buying more Treasury securities, instead of promising an extended period of low rates to support recovery, should inflation drift lower.

The FOMC's extended period language may be increasing the probability of a Japanese-style outcome for the U.S., and on balance, the U.S. quantitative easing program offers the best tool to avoid such an outcome. With a little bit weaker numbers on the economy and inflation a little bit low, people are starting to talk about the possibility of a Japanese-style outcome for the U.S.

The Fed's long-running promise to hold benchmark rates exceptionally low for an extended period — which is aimed at spurring growth — could lead businesses and consumers to anticipate slight deflation ahead. Deflation is much more dangerous than inflation with depressed confidence among consumers.

Strategically speaking, that isn't what the government is trying to do with the extended period language, what it is trying to do is encourage output growth and production, and through that channel, get inflation to move higher. Moreover, to view the most likely course for the U.S. economy as a gradual recovery and that more easing of financial conditions will not be necessary. FED should be prepared for further actions if unexpected shocks materialize. The language depicts lot of issues and consumers feel depressed and uncertain about the future.

Fed's strategy to stimulate debate about the effectiveness of the extended period language in achieving its goal of restoring stronger economic growth. Fed's lowered borrowing costs to near zero in December of 2008 and has already flooded the economy with more than $1.7 trillion of credit to boost growth after a painful recession.

The recovery has stumbled in recent weeks, and Fed Chairman Ben Bernanke has said the economy faces unusually uncertain prospects. The Fed could take further steps to bolster growth if needed.