(RTTNews) - St. Louis Federal Reserve Bank president James Bullard said Thursday that the U.S. economy is in a recession, and the economy is likely to continue to shrink in the first quarter of 2009. The economy continues to face “substantial turmoil,” he said, although he noted that the Federal Reserve stands ready to take additional action.

Speaking at the Regional Economic Summit in Evansville, Indiana, Bullard, one of many Federal Reserve Bank presidents to speak out lately, discussed what he called a “seismic change” on Wall Street, detailing why the face of the nation’s financial system will be permanently altered in the wake of the financial crisis.

Gross Domestic Product, a broad measure of economic performance, is “expected to fall sharply” in the fourth quarter, Bullard noted in his prepared remarks, adding that decline will likely be “followed by further but less-severe contraction in the first quarter of 2009.”

“If that scenario materializes, the contour of the current recession will look much the same as that of the 1990-91 recession,” he said.

He also warned about the possibility of deflation, and the debilitating effects it would have on the economy, effects that would be exacerbated by the current housing crisis.

Deflation, should it occur in the U.S., might be particularly challenging because some of the core problems we have are in housing markets, where contracts are written in nominal terms,” he said. “An unexpected deflation would make those contracts more expensive for borrowers.”

The St. Louis Fed President also offered a clue into future tactics the Federal Reserve will likely use, noting the explosion of new facilities and lending tools designed to assist liquidity-strained markets in ways other than simply lowering the federal funds rate. Hinting at further action, Bullard told the audience that “there may be many more twists and turns in the policy response going forward.”

Bullard addressed the notion that the recent extreme volatility in global markets and the economy as a whole has heralded the end of the period called the “Great Moderation,” a time of resilience for the U.S. economy that began in the mid 1980s. Although the current turmoil is exceptional, Bullard said, it is “too early to tell” if the era of Great Moderation is over.

“Even though financial market volatility is exceptionally high and even though the U.S. economy is contracting during the second half of 2008, the demise of the Great Moderation would require much more evidence than currently exists,” he said.

Still, the financial storm has battered Wall Street and brought about “once-unimaginable changes,” Bullard said.

“I think it is fair to say that we are witnessing a funeral for the financial system we knew over the past two decades,” he declared.

The failure of the nation’s top five investment banks to continue to operate solely as investment banks -or at all, closed the book on the era of the rise of investment banks, Bullard said.

He was also critical of the current system of bankruptcy court, stating that it is “not working.”

In addition, the Federal Reserve itself will be forever changed by the crisis, Bullard said, as he suggested that the importance of the federal funds rate will decrease in light of the new lending facilities established by the U.S. central bank.

“Monetary policy defined as movements in short-term nominal interest rates is coming to an end, at least for now,” he said.

“At least over the near term, any additional influence through interest rate reductions will be limited, and the focus of monetary policy may turn to quantity measures,” he added.

There will be more direct intervention in financial markets in the future, Bullard predicted, stating that “an important part of the response to ongoing financial market turmoil will come from fiscal policy intervention.”

“This runs counter to much of the thinking in macroeconomic policy circles over the past two decades,” he recognized. “It may be discomforting or rewarding or both, but stabilization policy in the coming months and quarters is likely to look very different from what we have been accustomed to seeing.”

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