Why We Need More Inflation, Not Less

In his most recent commentary, Paul McCulley of PIMCO echoes an argument I’ve been making for some time: We need more inflation, not less — at least more cyclical volatility of inflation. 

“The Fed can be too successful in cyclically fine-tuning inflation, if such success breeds irrationally thin risk premiums, the aftermath of which history has not dealt kindly!”

Thus, I argued, the Fed faced a dilemma (not a conundrum): if it set the inflation target too low and achieved it, asset bubbles would be the inevitable consequence, the eventual bursting of which would create fat-tailed deflation risk. Thus, ironically, the best prospects for achieving secular price stability would involve, I theorized, more, not less cyclical volatility in inflation, in a wider and higher band than 1-2%.

Investors need to have their hands burned regularly, and imagining that you have over-tuned all things economic is an exceedingly dangerous place to be. It breeds inappropriate risk-taking, moral hazard, and a general sense of investing omnipotence — right up until you smash into the wall as an investor and, potentially, as an economy. For example, the Fed would do well to make fewer and larger moves, as opposed to constantly looking like it’s diddling the dials to keep as all safe from our baser motives.


  1. Paul,
    I post your articles to reddit pretty frequently, and they rarely do well.
    I just want to let you know that my theory is that your content is so far beneath the fold that it’s hard for people to find quickly, and they leave your site. I read you on RSS, and it’s far more pleasant than your site.
    (To make this relevant: interesting link. How would you propose we acheive a more cyclical market? Could it be achieved simply by having the fed intervene in the market less?)

  2. Hey Bill
    Thanks for the note. I’m in the thick of redesigning the site, so with any luck the “below the fold” issue will go away somewhat in future.

  3. Mean Mister Mustard says:

    I agree with the post in the main. But I think it is short-sighted to focus exclusively on inflation. The problems of macroeconomic policies that aim to fine-tune away any cyclic changes is clear: they produce one giant policy of moral hazard. Recessions, inflation, etc. all happen for very good reasons.