Wikinvest Wire

McCulley on the Fed and inflation

Tuesday, June 23, 2009

Paul McCulley of Pimco talks to Kathleen Hayes at Bloomberg on topics in his most recent Central Bank Focus commentary and the outlook for the Fed policy meeting that begins today (strengthening of the "low rates for an extended period of time" language is suggested).

Click to play in a new window

He talks about the "irrational fear" of inflation at around the 4-5 minute mark - that pressure on consumer prices derives from too little "slack" in the economy (e.g., unemployment and under-utilization) which appears to be in abundant supply at the moment.

To wit:
It's very difficult for me to see an insipient inflationary problem. To be sure, you can get rising commodity prices but, actually, that weakens the economy because we're a net importer of commodities in the United States, so, if you look at inflation on an enduring basis as a function of "slack", I have difficulty getting there...
Formulating monetary policy and adjusting interest rates based on the amount of "slack" has worked so wonderfully over the last ten years, why would anyone think that it won't do so in the future?

From a related story at Bloomberg:
While the Fed has more than doubled its balance sheet to about $2 trillion, a surge in inflation is unlikely given unemployment is the highest since 1983, McCulley said. One policy likely to be used by the Fed involves paying more interest on the reserves banks hold at the central bank rather than taking them back. Some strategists have suggested the Fed will need to soak up the reserves before embarking on a higher interest rate policy as the economy shows signs of expanding.

“I think the monetarists are coming back out of the woodwork, as if the monetary base per se had a direct connection to inflation,” McCulley said. “It doesn’t. It’s certainly hard to argue we’re going to have an overheated economy any time soon, from a starting point of nine, perhaps up to 10 percent unemployment.”
It is downright scary that so many mainstream economists have absolutely no fear of the nearly trillion dollars worth of "high powered money" now sitting there as reserves on banks' balance sheets - they've been so wrong about so many things in recent years, why should this particular issue be any different.



Reginald said...

I thought this output gap nonsense was put to rest during the stagflation of the late 1970s. The economy kept slowing down (lower output), and price inflation accelerated. Albeit, we are told once again printing trillions of US dollars won't affect prices. This stuff defies common sense in the short-term, and falters in the long-term.

Anonymous said...

Not too long ago, the vast majority of economists had not a care in the world about runaway home prices. So this does not surprise me too much.

When I got my mother out of her GM bonds a few years ago, my broker told me that a GM default was "unthinkable", even though it was clear they were going under.

I think there is just some quirk in human thinking, that forces dismissal of big events that are well beyond anyone's control, as unthinkable. Being able to actually think about such things, and doing something about them is unfortunately a rare thing.

Ted S. said...

Both McCulley and Bernanke make the important distinction that this is not "true" quantitative easing because they're not just injecting money into the system, they are buying assets, as if those asset purchase will forever be worth what they paid AND not cause all kinds of new, unpredictable problems when they go to sell them. They are deluding themselves.

dangermike said...

come on... what happens when unemployment winds down and people are willing/able to take on credit again? Or what if wages come down as employment goes up? Either way, the dollar will be spread thinner. The only way we won't have inflation is if the fed is able to wind down it willy-nilly easy money precisely in time with the return of a healthy financial sector. And really, what are the odds of that happening?

Tim said...

I'm starting to see phrases like "their timing will have to be perfect" or, the much scarier, "thread the needle" when it comes to describing the task ahead in withdrawing all this money from the system while avoiding a sharp increase in inflation.

AJ said...

Many years ago, perfect timing would have been impossible. Now, however, with the Internet, we have a wealth of statistics all the time. This is not to say that it will be easy, but at least we know the exact dimensions of the thread and needle.

marku said...

Pretty much the only form of inflation that gets the Fed excited any more is in wages. As long as wages aren't going up, the Fed can be tripping over bubbles right and left but be assured that all is peachy keen.

Anonymous said...

Withdraw liquidity? What a joke! To do so, the Fed has to sell the bonds it has been stockpiling. And, more importantly, it would have to do so at a time when treasury yields will be much higher. Good luck with that. This isn't a question of being able to thread the needle. It is having the political will to make the difficult choices. For a preview of what happens when push comes to shove in this country, check out what's going on in California.

dangermike said...

@Tim: And I'm sure with your background, you understand how the indicators that will tell them when to withdraw don't develop until several months after that point has passed. It's beyond scary. We have to rely on clairvoyance from the same individuals who were unwilling to admit the existence of a housing bubble until about 6 months ago.

Anonymous said...

I think we may be missing the real point here. That is the government is not there to help. On the contrary, it desperately needs to coopt your productivity. As for the rest, human behavior cannot be reliably modeled and predicted with statistical economics. Pretty sure we just proved that ... again.

Joe Calhoun said...

The Fed even ignores its own research on the output gap nonsense:

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