Financial Times: Low rates don’t mean easy money
There are days where everything seems hopeless. I still find that 98% of the pundits I read don’t even understand that low rates don’t mean easy money. People still think that “austerity” is somehow determining the growth rate of NGDP. Yesterday NPR had an especially clueless discussion of the relative performance of the US and Eurozone, which merely served to reinforce the (false) priors of their mostly affluent liberal audience.
And then once and a while there is a tiny ray of hope:
Macroeconomic measures are caught in a deadlock between the conservative instincts of Germany and the expansionary needs of everyone else. To illustrate this incoherence the Bundesbank on Friday downgraded forecasts of German growth at the same time as its president complained that money was too loose.
Monetary policy provides the best key to understanding the variegated global picture. The central banks of the US, UK and Japan all adopted easier policies and were rewarded with an upturn. Given weak wage growth and a lack of fiscal support, such stimulus ought to continue.
Europe is an unhappy exception. Despite German misgivings, low interest rates are no evidence that money is too loose: nominal GDP growth stutters along at less than 3 per cent, a clear sign that the stance is much too tight. In recent years the ECB twice made the mistake of raising rates too soon, and thereby punished Europe with a deeper recession and a worse fiscal crisis. If its president Mario Draghi cannot ease policy further, the consequences will be just as serious.
By the way, remember those people who told us that the eurozone’s problems were all “structural,” and that NGDP growth wasn’t a problem? That was when the PIIGS were plunging lower and Germany was growing fast. Doesn’t that logically mean that if the PIIGS start recovering then the eurozone will grow faster? In contrast, if a lack of NGDP growth is the problem, faster growth in the PIIGS will be offset by slower growth elsewhere. Keep those two hypotheses in mind as you read this:
“THE world cannot afford a European lost decade,” says Jacob Lew, America’s treasury secretary. The latest European figures were uninspiring. In the third quarter the euro zone grew by just 0.6% at an annualised rate. This sluggishness was not primarily due to the countries hit hardest by the crisis””Greece’s economy grew faster than any other euro-zone country, and Spain and Ireland are recovering. Rather, it is the core countries that are exhausted””and few more so than the biggest, Germany. It grew by just 0.1% in the third quarter, after contracting by the same amount in the previous three months.
Just to be clear, Europe does have plenty of structural problems. That’s why they are 30% poorer than the US. But that doesn’t mean that slow NGDP growth is not also a problem.
PS. I’ve recently been sent many papers to read and comment on. Right now I am overwhelmed with work, but promise to get to them when the semester ends.
PPS. The original version of the post erroneously stated that Martin Wolf wrote the article. My mistake.
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6. December 2014 at 11:14
Leland J Pritchard – Chicago school – 1933 and a classmate with Milton Friedman:
Discussions of interest, especially short-term rates, are usually couched in terms of the “money market”. As long as this is just a “street-wise” expression confined to the business community, no harm is done. Unfortunately, under the influence of the Keynesian dogma, academicians have been trying for too long to analyze interest rates in terms of the supply of, & demand for – money.
A “liquidity preference” curve is presumed to exist which represents the supply of money. In this system interest is the cost which must be paid, if lenders are to forgo the advantages of liquidity. All of this has little or nothing to do with the real world, a world in which interest is paid on checking accounts.
Interest, as our common sense tells us, is the price of obtaining loan funds, not the price of money. The price of money is the inverse of the price level. If the price of goods & services rises, the “price” of money falls. Interest rates in any given market at any given time are the result of the interaction of all the forces operating through the supply of, & the demand for – loan-funds.
Loan-funds, of course, are in the form of money, but there the similarity ends. Loan-funds at any given time are only a fraction of the money supply — that small part of the money supply which has been saved, & is offered in the loan credit markets. Unfortunately, Keynesian economists have dominated the research staffs of the Fed, as well as the halls of academia.
While monetary policy is formulated by the Federal Open Market Committee (FOMC), monetary procedures are determined by the “academic” research staffs. In their world, high interest rates are evidence of “tight money”, low rates of “easy money”; &, a proper rate of growth of the money supply is obtainable by manipulating a policy rate. Consequently, to bring interest rates down the money supply should be expanded & vice versa.
The only instance in which an expansion of the money supply is synonymous with an increase in the volume of loanable funds involves an expansion of commercial bank credit. When the depository institutions make loans to, or buy securities from, the non-bank public, an equal volume of new money (demand deposits) is created. This expansion is made legally possible by a growth of legal reserves (clearing balances) in the banking system, which in turn is the consequence of net open-market purchases by the Reserve banks.
To increase the volume of legal reserves in the member banks, the Fed buys governments, (usually T-Bills) in the open market in sufficient quantity to more than offset all legal reserve consuming factors (e.g., the withdrawals of currency from the banks by the non-bank public). These purchases tend to increase the price of bills, thus reducing their discounts (interest rates). The incremental reserves also add to excess reserves thus enlarging the supply of “federal funds”. Federal funds rates are thus held down, or are prevented from rising.
The long-term effects of these operations on short-term rates are just the opposite. The banks are able to (& do) expand credit on a multiple basis relative to the additional excess reserves.
This “multiplier effect” on the money supply, & money flows, puts additional upward pressure on prices. The long term effect, therefore, is higher inflation rates, & a higher “inflation premium” in both short & long-term interest rates.
Higher interest rates consequently are not evidence of “tight money”; rather they are the consequence, over time, of an excessively easy (irresponsible) money policy – money expansion so great that monetary flows (MVt) substantially exceed the rate of expansion in real-output.
While interest rates are not determined by the supply of & the demand for money, changes in the volume of money & monetary flows (MVt), as noted above, can alter rates of inflation &, therefore, the supply of, & the demand for – loan-funds.
The significant effects of these monetary developments are long-term & involve an alteration in inflation expectations. Inflation expectations operate principally through the supply side for loan-funds. Specifically, an expectation of higher rates of inflation will cause the supply schedules of loan-funds to decrease. That is to say, lenders will be willing to lend the same amount only at higher rates.
Under the assumption of increasing rates of inflation, the supply of loan funds would decrease in both a quantitative and schedule sense. I.e., lenders reduce the volume of loan funds offered in the markets & refuse to loan any particular volume of funds except at higher rates.
At the same time supply is decreasing, the demand for loan -funds can be expected to rise as a consequence of the expected massive increases in federal deficits. With supply decreasing & demand increasing (in the schedule sense), there is only one way for interest rates to go – up.
6. December 2014 at 12:36
The semantics is an issue here. Low rates *do* mean easy money compared to the counterfactual where everything was the same except rates being higher.
That is an acceptable interpretation of these words. Ignoring this meaning is an obstacle to communication and to the promotion of your ideas.
It is also true that low rates compared to rates in another situation (maybe a previous situation) doesn’t mean easier money. This is also an acceptable interpretation. But you have to specify which interpretation you are using and you can’t assume that when people say low rate mean easy money than they mean easier than before, they could mean easier than the hypothetical counterfactual where they would be higher.
Making sure this is clear for everyone would help the discussion move forward.
6. December 2014 at 12:47
Dr. Sumners I have always meant to ask you about low interest rates. In the money market graph you used in a former blog. The vertical axis had 1/P, which I agree.
But then some books also used Nominal interest rates in the vertical axis. I think that is wrong. Higher demand for money increses deflation and real rates. It does not increase nominal interest rates. Nominal interest rate drop with high money demand because there is less Investment Demand.
Am I wrong or textbooks just have not figure it out? I have not found any source that discusses this problem. I would appreciate if you can lead me to a source.
6. December 2014 at 13:27
“Doesn’t that logically mean that if the PIIGS start recovering then the eurozone will grow faster?”
Not necessarily, because ceteris paribus doesn’t hold in the real world.
Come on!
6. December 2014 at 13:29
“But that doesn’t mean that slow NGDP growth is not also a problem.”
It also does not mean that more inflation is not a problem.
6. December 2014 at 13:44
Benoit, You said:
“The semantics is an issue here. Low rates *do* mean easy money compared to the counterfactual where everything was the same except rates being higher.
That is an acceptable interpretation of these words.”
No, it’s not acceptable. If everything else is the same, then rates can’t be different. Draw a supply and demand diagram with interest rates on the vertical axis. Now change interest rates without changing either the supply or demand for money. It’s impossible.
Interest rates are the price of credit, they should not be brought into any discussion of monetary policy. Every time I criticize people for using interest rates to talk about the stance of monetary policy they are misusing the concept.
tesc, You can put i-rates on the vertical axis, but it’s not really a good idea, as money supply and demand are not independent. A change in the money supply causes money demand to change as well. Better to use 1/P on the vertical axis in intro econ courses.
6. December 2014 at 14:03
“Now change interest rates without changing either the supply or demand for money. It’s impossible.”
Au contraire. See: “Should Commercial Banks Accept Savings Deposits?” by Leland J. Pritchard, Edward E. Edwards, and Lester V. Chandler at the 1961 Conference on Savings and Residential Financing in Chicago, Illinois,
6. December 2014 at 14:06
THE SAVINGS-INVESTMENT PROCESS OF THE COMMERCIAL BANKS CONTRASTED TO THAT OF FINANCIAL INTERMEDIARIES:
(A) The commercial banks create new money (in the form of demand deposits) when making loans to, or buying securities from the non-bank public; whereas lending by financial intermediaries simply activates existing money.
(B) Bank lending expands the volume of money & directly affects the velocity of money, while intermediary lending directly affects only the velocity.
(C) The lending capacity of the commercial banks is determined by monetary policy, not the savings practices of the public.
(D) The lending capacity of financial intermediaries is almost exclusively dependent on the volume of monetary savings placed at their disposal. The commercial banks, on the other hand, could continue to lend if the public should cease to save altogether.
(E) Financial intermediaries lend existing money which has been saved, and all of these savings originate outside the intermediaries; whereas the commercial banks lend no existing deposits or savings: they always, create new money in the lending & investing process.
(F) Whereas monetary savings received by financial intermediaries originate outside the intermediaries, monetary savings held in the commercial banks (time deposits & the saved portion of demand deposits) originate, with immaterial exceptions, within the commercial banking system. This is demand deposits constitute almost the exclusive net source of time deposits.
(G) The financial intermediaries can lend no more (and in practice they lend less) than the volume of savings placed at their disposal; whereas the commercial banks, as a system, can make loans (if monetary policy permits & the opportunity is present ) which amount to several times the initial excess reserves held.
(H) Monetary savings are never transferred from the commercial banks to the intermediaries; rather are monetary savings always transferred through the intermediaries. The funds do not leave the banking system.
(I) If time deposit banking is to add to the aggregate profits of commercial banks as a system, it is necessary to assume that the expansion of time deposits per se induces the Federal Reserve to alter monetary policy toward greater ease (or less restraint) to the extent necessary to supply the banking system with an added volume of excess reserves adequate enough to enable the banks to expand their earning assets, & thereby their net earnings, by an amount sufficient to more than offset the overall increase in costs associated with the growth of time deposits.
(J) The growth of time deposits n commercial banks denies savings to intermediaries, reduces lending opportunities for all institutions (including the commercial banks), and slows down the tempo of business activity; since in their time deposit function, the commercial banks are neither intermediaries nor creators of loan-funds but are simply custodians of stagnant money
(K) The growth of financial intermediaries has no effect per se on the aggregate assets, earnings assets, gross income, or net profits of the commercial banks as a system; but their growth does activate monetary savings and tends, therefore, to increase the lending opportunities of the commercial banks. The growth of financial intermediaries should, therefore, enhance commercial bank earnings. & profits, if the Federal Reserve permits the commercial banking system to exploit their expanded lending opportunities.
6. December 2014 at 14:59
Excellent blogging. But there is an implacable clan embedded in the world of monetary policy, for whom monetary policy is always too easy and for whom the nirvana of zero inflation trumps all, even robust growth. It is faith-based economics.
6. December 2014 at 15:35
“Just to be clear, Europe does have plenty of structural problems. That’s why they are 30% poorer than the US. But that doesn’t mean that slow NGDP growth is not also a problem.”
Great point – I encourage you to hammer this home repeatedly. The debate seems to start off with people criticizing your monetary proposals as dangerous or harmful, then retreating into the “monetary policy doesn’t matter, all our problems are structural” stance. Just because monetary policy isn’t the only problem in the world, doesn’t mean we shouldn’t fix it. And your proposal is the best monetary fix that I’ve encountered.
Keep up the good work.
6. December 2014 at 15:44
I’ve recently been sent many papers to read and comment on.
Take it for the compliment it is 🙂
On the “rays of hope” issue, convincing someone like Andrew Sullivan would be useful. He is much more of an admirer of Obama than you are, but otherwise your politics are actually very similar. Alas, he has drunk the Larry Summers KoolAid and believes that Obama “saved us” from another Great Depression. He is, however, the sort of intelligent lay voice that would be helpful, if it were possible to get him onside.
6. December 2014 at 16:05
Thanks Lorenzo, and I haven’t forgotten your paper. I like Sullivan, but don’t have time to read him anymore, unless someone links to something interesting.
6. December 2014 at 16:06
Thanks Ben and Negation.
6. December 2014 at 17:35
Benoit, why are you complaining that Scott has been unclear on this matter? In the quote from the FT, in literally the sentence following the one where the author says that low interest rates don’t mean easy money, he writes:
“In recent years the ECB twice made the mistake of raising rates too soon, and thereby punished Europe with a deeper recession and a worse fiscal crisis.”
You see? Low rates don’t mean easy money, but rate hikes mean tighter money, so long as it’s someone who subscribes to Scott’s worldview. Why is this confusing to you?
6. December 2014 at 18:16
Murphy:
If the EU goes into recession, and spending falls, and during this, interest rates rise, then we can say the ECB made the mistake of raising rates and pushing the EU into recession. As long as Sumner knows you know that by “raising rates” you really mean “decreasing NGDP”, but you know that he knows that you know that you are only talking about rates so that others who subscribe to that view know that you know what they know when they mean the ECB caused the recession.
But where things go wrong is where what you think Sumner knows you know isn’t really what he knows you know, so that when you say the ECB caused the recession by raising interest rates, it is then that you said the wrong thing, because what you know isn’t what you are supposed to know, because what you should know is NGDP.
This like totally makes sense.
6. December 2014 at 18:59
Bob Murphy wrote:
“You see? Low rates don’t mean easy money, but rate hikes mean tighter money, so long as it’s someone who subscribes to Scott’s worldview. Why is this confusing to you?”
I don’t understand this particular criticism. If the Fed funds target is cut from 2% to 1%, that would be monetary easing (relative to the counterfactual of keeping the target at 2%). That doesn’t imply that 2% is tight money and 1% is loose money.
If you get a raise (in real terms), that means your salary is higher in real terms. You make more money than you did before. Relative to the counterfactual in which you didn’t get a raise, you are better paid now than you were before. That doesn’t imply that you were underpaid before the raise or that you are overpaid after it – in fact you could have been either overpaid or underpaid both before and after the raise. The stance of your employer (in regard to your salary) become looser; that doesn’t mean it was tight before or that it is loose now.
6. December 2014 at 19:37
Michael Byrne’s:
“I don’t understand this particular criticism. If the Fed funds target is cut from 2% to 1%, that would be monetary easing (relative to the counterfactual of keeping the target at 2%). That doesn’t imply that 2% is tight money and 1% is loose money.”
Why wouldn’t rates falling be monetary tightening? You are declaring something that Sumner would not agree with.
If we are just going to declare things, then if NGDP falls below 4.5%, that would not imply tight money.
6. December 2014 at 20:06
Is there a definition of loose and tight money that is not far backward looking? The definition here seems to be “If NGDP did not increase by an acceptable amount, then money was too tight”. If this is the case, then what about other factors?
Or, is this part of the theory like trying to drive on ice: speed up until you start sliding, then ease off until you regain traction. Money is just right if you are on the edge of sliding. It seems to take years of data to recognize sliding.
Possibly there is a thoughtful article I could read, accepted by most economists, about deciding what is loose and tight money which could guide policy after just one quarter of results.
6. December 2014 at 20:16
Michael Byrnes wrote to me:
“I don’t understand [your] particular criticism. If the Fed funds target is cut from 2% to 1%, that would be monetary easing (relative to the counterfactual of keeping the target at 2%). That doesn’t imply that 2% is tight money and 1% is loose money.”
*I’m* not saying I have a problem with that way of talking, Michael; it’s what Brad DeLong and Krugman do. They say that yes, the Fed under Bernanke engaged in unprecedented monetary stimulus, but gosh darnit it just wasn’t enough, because of the pesky ZLB.
But that’s not what Scott thinks. Look above, when Benoit proposed a framework just like yours. Scott took him out to the woodshed, writing:
“Benoit, You said:
“The semantics is an issue here. Low rates *do* mean easy money compared to the counterfactual where everything was the same except rates being higher.
That is an acceptable interpretation of these words.”
No, it’s not acceptable. If everything else is the same, then rates can’t be different. Draw a supply and demand diagram with interest rates on the vertical axis. Now change interest rates without changing either the supply or demand for money. It’s impossible.
Interest rates are the price of credit, they should not be brought into any discussion of monetary policy.”
You see the contradiction now, Michael? Interest rates should not be brought into any discussion of monetary policy–except, presumably, when Scott or the FT criticize the ECB for raising interest rates and thereby causing a double-dip recession.
Incidentally, my point in this isn’t to say Scott’s framework is incoherent. I know what he means. For example, if the Fed announced on Monday that it would achieve catch-up with the 2007 trend of NGDP by June 2015 come hell or highwater, then (he thinks) interest rates would zoom up. So that would be easier money going hand in hand with “rate hikes.”
All I’m pointing out is that Scott gets so frustrated at people for using a shortcut that he and his buddies are allowed to use. I know Scott’s objections, and I still think it is perfectly sensible to say Bernanke engaged in outrageously easy money. One indicator of that is the collapse in nominal and real interest rates.
6. December 2014 at 20:22
BTW Benoit, in case you are not familiar with wise-aleck Americans, let me clarify that I was never criticizing you, above. Instead I was sarcastically criticizing Scott for saying that you weren’t allowed to use a framework for evaluating interest rates that the FT article used in the very quotation Scott provided.
6. December 2014 at 20:50
This man–Dr. Scott Sumner–is a genius, a prophet, a sage! Everything –and I mean everything–Dr. Sumner says must be carefully studied, like scripture, akin to the musings of other past giants like Friedman, Keynes, Hayek, Mises and the like. That’s why when I read this sentence I was temporarily taken aback, until I realized probably it’s simply badly written due to the crush of time: Sumner: ” People still think that “austerity” is somehow determining the growth rate of NGDP.” Wow?! I must tread lightly here. Does this mean that Dr. Sumner is repudiating all of his past teachings? Does it mean austerity is irrelevant to NGDP? But that would seem to repudiate Dr. Sumner’s past teachings about targeting NGDP? Surely it is simply a badly written sentence. Or it has some deeper, darker, more profound meaning.
Off-topic to Major Freedom: read this article, found online: RICHARD N. COOPER, Harvard University, “The Gold Standard: Historical Facts and Future Prospects” Brookings Papers on Economic Activity, 1:1982 (written in a neutral tone, awesome summary, shows that even back in the classic Gold Standard of 1870-1914, central banks practiced tricks as done today, such as sterilizing gold inflows, so essentially gold standard management becomes modern fiat money management, albeit prices were more stable back then)
6. December 2014 at 21:56
@Ray Lopez: Yes, fiscal austerity is irrelevant to NGDP, due to monetary offset. (At least, given a competent central bank targeting some nominal aggregate.)
“But that would seem to repudiate Dr. Sumner’s past teachings about targeting NGDP?” In what way? Perhaps you can try to be more specific about whatever conflict you think you see.
6. December 2014 at 22:00
@Andrew_M_Garland: “Is there a definition of loose and tight money that is not far backward looking?”
An NGDP futures market could give you instantaneous feedback about the current tightness of money. Of course, the US has unfortunately made illegal most futures markets, so in the meantime you can look for 2nd-rate alternatives like the spread between TIPS and regular Treasuries.
6. December 2014 at 22:25
Ray, thanks for the link. I advocate for a free market in money, not a gold standard. Every state enforced standard will be corrupted, because the seed of state enforcement is already corrupted.
The root of all evil is initiations of force. With it, states are possible. With states, coercive monopolies in money are possible. With state monopolies in money, society has to put up with moral coward opportunists publishing an endless series of awkward, logically flawed academic capitulations, apologies, defenses, and strategy manuals for it.
6. December 2014 at 22:28
Don’t Geddis:
“Of course, the US has unfortunately made illegal most futures markets.”
Why not? They have already made illegal monetary competition, which you support. You people are such flipping hypocrites it’s not even funny anymore.
6. December 2014 at 22:30
Bob Murphy:
“All I’m pointing out is that Scott gets so frustrated at people for using a shortcut that he and his buddies are allowed to use. ”
You’re a smart guy, so… are you trying to be purposefully obtuse? Or do you genuienly not see the distinction between the observations “the overall *level* of interest rates does not give reliable information about the stance of monetary policy” and “an increase or decrease in the policy rate is a change in policy that can be interpreted relative to the previous stance of the policy maker”. We also have the additional context of the stated (and implicit) goals of the policy maker.
If I mysteriously offered you 100 Ben J currency units, obviously you could not infer their overall value immediately. However, if I tell you (truthfully) that 1 Ben J unit bought less USD today than yesterday, you can infer that their value is falling relative to the USD.
Is there something confusing about this?
7. December 2014 at 00:42
@Don Geddis -thanks for that clarification, it now makes sense. I was thinking “society’s austerity” rather than government fiscal austerity.
@ Major Freedom – you are welcome; one correction: it turns out the data in the period of 1881-1913 in the gold standard era is bad in a source I consulted, so in fact while inflation was lower then than now, prices actually were decreasing and then increased after 1900 so volatility was greater then than now (no ‘Great Moderation’ or ‘shock absorbers’ back then), see more here: http://marginalrevolution.com/marginalrevolution/2014/12/how-technology-might-someday-fight-income-inequality.html#comment-158407792
7. December 2014 at 05:39
Murphy:
Sumner would prefer that no one use interest rates to discuss monetary policy. He also would prefer that no on use inflation.
But most economists use both, as do pundits. Scott is constantly commenting on these views. Sometimes he is giving credit and sometimes being critical. And sometimes he even uses their language–interest rates and inflation.
By the way, some of this “puzzle” can be solved by distinguishing between tight and tighter and loose and looser.
Suppose nominal GDP is growing 5%, base money is growing 5%, the nominal interest rate is 5% and so is the interest rate on reserves.
Government austerity (deficit reduction) impacts credit markets and the nominal interest rate falls to 3%, the interest rate on reserves is cut to 3%, but hte growth rate of base money continues at 5% and nominal GDP continues to grow 5%.
The interest rate is lower, but money is not tighter. The demand for credit fell. The quantity of money and the demand to hold money both continued to grow as before. Monetary equilibrium was maintained.
Now, suppose the Fed decides that 3% is too low for interest rates and will lead to excessive speculation. So, it slows the growth rate of base money to 1%. Banks are short on reserves and sell off T-bills and other short term securities. Their yields rise. The nominal interest rate rises to 5%. The Fed raises the interest rate on reserves to 5%. Nominal GDP growth slows to 1%.
That was tight money, and led to a recession.
Because of the recession, the demand for credit goes down, which lowers interest rates to 4%. Now, suppose the Fed wants to keep interest rates at 5%, and starts shrinking base money by 1%. Suppose they do this so quickly that the supposed decrease in interest rates never happens. Money was tight and just got tighter.
And then, we get into this question of definition If the Fed wants 5% nominal GDP growth, money is too tight and it will stay to tight until base money returns to the appropriate growth rate.
But what if the Fed _wants_ nominal GDP to grow 1%?
OF course, the growth rate of base money doesn’t define whether money is loose or tight either. Suppose we are at the original equilibrium. Suppose base velocity begins to growth 1% (rather than remain constant as was implicitly assumed before.) Then the 5% base money growth is loose money. It is possible, and even likely, that some of the excess money will be used to purchase securities, raise their prices, and reduce their yields. The nominal interest rate will go down.
But as we saw in the first scenario, lower interest rates aren’t necessarily loose money.
To avoid loose money, the Fed would need to restrict base money growth to 4%. So, while in the first scenario, the slow down in base money growth tightened money and made it tight, when the base money slowdown accommodates a change in velocity, it prevents loose money, and isn’t making money loose or tight.
This entire story above can be told using inflation and it is the exact same as long as potential output grows at a constant rate and there are no supply-side shocks to the price level. (Generally, I see this as being two sides of the same coin–some supply curve shifted left (or up.)
7. December 2014 at 06:18
Andrew, Bernanke argued you should ignore the money supply and talk about NGDP growth and inflation. I prefer NGDP growth.
And no, there are no good articles discussing the stance of monetary policy, someone should write one. If I had time, I would write one.
NGDP futures prices provide the best indicator of the stance of monetary policy.
Bob, I know that you keep claiming that money was really tight during the Germany hyperinflation, because interest rates were high and rising, and that money was really loose during the early 1930s, because rates were low and falling. But I don’t believe you. You must just be trying to tease me. The alternative is too horrible to contemplate.
One last time, when the central bank changes it interest rate target, it may tell us something about how they intend to adjust the stance of monetary policy on the day they changed the target. But it tells us nothing about whether money is easy or tight–that depends on the relationship between the policy rate and the Wicksellian equilibrium rate. That is, if you insist on talking about interest rates, which is really foolish, as is talking about inflation.
7. December 2014 at 09:05
Having called both the bottom in bonds (in Sept 1981), and the top in bonds (July 2012), in the 31 year bull market, I know something about interest rates. Tight money is simply where the rate-of-change in money flows (the proxy for inflation), is falling. Easy money is where the roc is rising. Money flows = money X velocity. So, given the lag effect of long-term money flows, tight or easy money can’t be clearly inferred by the level of market interest rates in the short-run. If the Fed initiates an easier money policy, market rates may or may not initially fall (depending on whether the trend in MVt is currently rising, falling, etc).
A spectacular example of the short-run vs. the long-run impact of monetary policy is demonstrated by Volcker’s response to inflation after his announcement on Oct 6 1979. Paul Volcker’s version of monetarism (along with credit controls: the Emergency Credit Controls program of March 14, 1980), was strictly limited to the 3 months of Feb, Mar, & Apr of 1980. During this period 3-month T-Bills rose from 10.7% on 10/05/1979, to 16% on 3/25/1980 (easy money), then fell to 6.20% on 6/11/1980 (tight money). Market rates fell dramatically in response to Volcker’s tightening (as the roc’s in both short, and long term, money flows simultaneously contracted).
For 2014, long-term money flows crested in May (lower than its peak in 7/2013), and have steadily decelerated over a prolonged period (reflecting an extremely tight money policy – despite QE3). As a result of the continuation of this tight money policy, the 30-Year Treasury Constant Maturity Rate has fallen nearly a full percentage point this year. The theoretical trough is 12/11/14.
I.e., Scott Sumner has always been right when he has frequently referenced low interest rates as an indication of monetary mis-management (tight money).
7. December 2014 at 16:55
I suspect the FT Editorial is the work of Giles Wilkes, formerly of this parish (https://freethinkecon.wordpress.com/2014/09/14/all-that-reading/).
As is often quoted, you don’t change people’s policy views, you change the people who make policy. There will be a cadre of people moving gradually into influential positions who understand the points Scott is making. Eventually however they will be the old dinosaurs that some future Scott will be railing against.
7. December 2014 at 17:53
A country in in negative inflation (Greece-for 20 months-)
-1.8% HICP in October 2014
http://www.statistics.gr/portal/page/portal/ESYE/BUCKET/A0515/PressReleases/A0515_DKT90_DT_MM_10_2014_01_F_EN.pdf
projection for RGDP 0.6% in 2014,
http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-05122014-AP/EN/2-05122014-AP-EN.PDF
and given the trend -lower oil prices- HICP inflation could be near -1.2% with real GDP to 0.6%.
NGDP is negative!
Structural reforms have long term positive results but are a disaster if only to change unit labor costs
http://www.docdroid.net/file/view/mm83/d1.pdf
from Mark Cliffe page 11/26
http://www.markcliffe.com/
presentation
8. December 2014 at 17:34
ChrisA, Thanks, and that does sound like his views.
9. December 2014 at 06:05
The current turbulence in the markets (7% drop in crude on 11/28/14), is simply due to “tight money” (as the protracted decline in interest rates signifies). I.e., low rates are obviously telling.
Crude recently dropped like stocks on 5/6/10 and yields on 10/15/14 – for exactly the same reason (a combination of short and long-term monetary policy blunders).
The price level is validated by the FOMC’s actions. Just as the Fed turned safe assets into impaired assets through a prolonged and deliberately orchestrated (3 ½ years), deceleration in nominal-gDp, the Fed’s current tight money policy (QE notwithstanding), has exacerbated the current decline in oil prices.
The price level and long-term rates are inextricably linked. The capitulation in oil on 11/28/14 was due to a long standing policy error. The weakness since 11/28/14 is due to a short-term policy error, which is due to reverse on 11/11/14 – absent any front-running.
9. December 2014 at 06:27
Honest question. I would appreciate honest insights from any commenters.
Since July, the Dollar has appreciated significantly against the Euro and Yen. Is this caused by market consensus that Euro and Japanese money supply will increase relative to Fed money supply?
This scenario presumes that current imbalances of payments are essentially offset by imbalances of capital transfers.
Thanks in advance.
9. December 2014 at 13:25
Moneys is ‘easy’ for those with access to credit or markets which create financial wealth … and tight for those who lack credit, jobs or capital.
WHatever the economist or political persuasion, we remain preoccupied with getting more money to those who already have money.
10. December 2014 at 18:33
Todd, Currencies can be impacted by both money supply and money demand shifts. The recent strength of the dollar may reflect the fact that we are growing much faster than Japan and Europe, but that’s just a guess. Perhaps expectations of more QE in Japan and Europe as well.
13. December 2014 at 11:17
Can anyone help me with a link to one of Scott’s posts on the causes of increase/decrease in money demand? Especially vis-Ã -vis change in demand relative to other currencies?
If so, thanks in advance.
13. December 2014 at 11:33
A contractionary money policy has driven up the dollar since July.
5/1/2014 ,,,,, 0.39
6/1/2014 ,,,,, 0.34
7/1/2014 ,,,,, 0.34
8/1/2014 ,,,,, 0.32
9/1/2014 ,,,,, 0.28
10/1/2014 ,,,,, 0.26
11/1/2014 ,,,,, 0.27
12/1/2014 ,,,,, 0.24
1/1/2015 ,,,,, 0.24
2/1/2015 ,,,,, 0.28
3/1/2015 ,,,,, 0.25
I.e., long-term money flows (proxy for inflation indices), decelerated by 38 percent.
This wouldn’t have happened if the Fed was targeting nominal-gDp.