PIMCO’s Paul McCulley has defended the actions of Federal Reserve Chairman Ben Bernanke saying he is doing exactly what he is meant to be doing.
McCulley takes aim at those individuals who have lashed out at Bernanke’s unorthodox actions to combat deflation, saying he is only playing the Fed’s part in the policy “hat-trick” that could save the U.S. economy.
The explanation McCulley provides is that the U.S. is in a liquidity trap, brought on by a deleveraging society unwilling to spend. The Fed, according to McCulley, has done all it can by lowering interest rates. Now it must engage in other activities:
- Openly coordinate itself with the fiscal authority, accommodating increased fiscal expansion, for example printing money to finance an economy-wide tax cut.
- Openly encourage higher short- to intermediate-term inflation expectations, via an interregnum of price level targeting, rather than year-by-year inflation targeting, implying that below-target inflation sins are not forgiven, but recovered with above-target inflation rates, until the constantly-growing long-term price level path is restored.
McCulley calls Bernanke’s decision to follow this path, initiating QE2, “courageous” and “acting unconventionally relative to orthodoxy.”