McCulley on the Fed and inflation

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).

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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.

ooo