Yes, the economics profession really does believe low interest rates mean easy money

People get defensive when I make fun of the view that low interest rates mean easy money.  They insist that; “all good economists understand that rates are strongly impacted by real growth and inflation expectations, and that the liquidity effect is just one factor.”  OK, let’s look at the NGDP growth rates for Australia in the late 1980s and early 1990s, and then see how one leading Australian Keynesian responded to this data.  I use Q4 to Q4 growth rates:

1986:4 to 1987:4:  14.1%

1987:4 to 1988:4:  13.3%

1988:4 to 1989:4:  11.2%

1989:4 to 1990:4:  3.5%

1990:4 to 1991:4:  1.1%

Now what would you expect to happen to Australian interest rates, just on the basis of that dramatic slowdown in NGDP growth, which represented Australia’s “Paul Volcker moment?”  I’d guess you’d expect a dramatic fall in interest rates, comparable to what we saw in 1982 in America.  And that’s what happened.  Here’s John Quiggin:

A commenter on the previous post raised the idea, promoted by the “market monetarist” school, that monetary policy is so effective as to make fiscal policy entirely unnecessary, at least when interest rates are above the zero lower bound. My views on this issue were formed by the experience of the late 20th century, and in particular, the recession that began in 1990, following steep increases in interest rates. Having planned a “short, sharp, shock”, the RBA started cutting rates in January 1990.

They didn’t go for 25 basis point moves in those days. Over the period to December 1992, rates were cut by more than 12 percentage points, from 17.5 per cent to 5.25 per centOver the same period, unemployment rose from 6 per cent to 10.9 per cent, a record for the period since the Depression. As I said in the previous post, tight monetary policy can reliably cause recessions, but expansionary monetary policy in a deep recession is “pushing on a string”.

Where does one begin?  A critique of market monetarism using interest rates as an indicator of the stance of monetary policy?  Perhaps he doesn’t know what market monetarism is.  But why in the world would anyone assume that this sort of drop in interest rates was related to easy money?

Later (in comments) Quiggin mocks anyone who believes low rates might reflect tight money:

OK then, I’ll make some points on the data. First, the starting point for the cash rate was 17.5 per cent, as I said in my post, not 15.8 per cent. So, to restate, the cut was about 12 percentage points. If you can call this a contraction, I think you are in Humpty Dumpty territory.

This leaves me speechless.  I had thought everyone agreed that the bigger the change in interest rates the LESS LIKELY it was due to the liquidity effect. I could do some cheap shots here and talk about how the number one money textbook in America, written by respected moderate and former Fed official Ric Mishkin believes in Humpty Dumpty, or that Ben Bernanke does, or Milton Friedman.  Or that Quiggin seems to align himself with Joan Robinson, who famously insisted in 1938 that the German hyperinflation couldn’t be due to easy money because interest rates were not low.

But I have to admit that Quiggin is right.  Most economists do equate low rates with easy money.  That is the accepted definition.  How that occurred, how the lunatics took over the asylum, is beyond my comprehension.  But it happened, and that’s one reason for the policy failures of the past 5 years.

Keynesians are the worst, but conservatives these days are almost as bad.

PS.  Of course I’m not claiming Quiggin is a lunatic, just a conventional Keynesian.  It’s the ideas of this group that seem crazy to me.

PPS.  Mark Sadowski has an interesting debate with Quiggin in the comment section.

PPPS.  The Australian central bank actually wanted a sharp slowdown in demand, so in no sense was this a failure of monetary stimulus.  Central banks generally get what they ask for.  The Fed current thinks 1.8% first half RGDP growth is adequate, so they are about to taper.  The economy is right on target (in the Fed’s view). Fiscal austerity offset.  Mission accomplished.



18 Responses to “Yes, the economics profession really does believe low interest rates mean easy money”

  1. Gravatar of jknarr jknarr
    29. August 2013 at 11:34

    They confuse a “present value effect” on cash-flow assets with “easy money”.

    Easy money, in reality, damages present value — by making cash flows more abundant. Tight money makes cash flows scarcer, and so raises present values.

    What is a good way to make this distinction clearer?

  2. Gravatar of Joshua Joshua
    29. August 2013 at 11:40

    Didn’t RGDP revisions push the 1.8% growth to 2.5%?

  3. Gravatar of Grim23 Grim23
    29. August 2013 at 12:31

    My take went like this;

    Low interest rates don’t necessarily show money is tight, but show that money has been tight. After the RBA cut rates by 12%, NGDP DID start growing again.

    Money was way too easy in the late 80s and that was causing high inflation. To break inflation the RBA engineered a recession using tight money. By 1993, once the RBA had cut rates by 12%, NGDP was growing at a trend of between 5 and 6% until 2005/6 (except for a spike around 2000). So by 1993, money was still “tight” relative to its old trend line, but “neutral” relative to the new trend line. Unemployment remained elevated because wages took time to adjust to the new NGDP trend.

  4. Gravatar of Doug M Doug M
    29. August 2013 at 13:22

    You are short on data… I understand your rationale for NGDP, but the economics profession looks at RGDP. What really should have is RGDP yoy, Inflation yoy and the rate at each year end. (including 1985 as your starting point).
    AU GDP AUCPI 1y rate
    1985 17.6
    1986 2.3 9.6 14.4
    1987 6.3 7.2 11.0
    1988 3.1 7.6 14.5
    1989 4.0 7.8 15.6
    1990 1.0 6.9 7.076
    1991 -1.1 1.5 5.799

    So, if low rates are easy money… money was tight becoming gradually less tight lading up to year end 1987. Got tight again and was significantly eased in 1990.

    Now conventional economic thinking would suggest that money operates with variable lags, so there is nothing inconsistent with seeing signs that growth is about to falter, cut rates (easing money) and the economy going into a recession nonetheless. With the power of easy money not kicking in until 1992.

    I am not trying to defend the conventional wisdom, but it appears that you are trying to mis-represent it.

  5. Gravatar of Tommy Dorsett Tommy Dorsett
    29. August 2013 at 14:01

    So the policy rate was above NGDP growth during the episode in which Quigglin says money was easy? Epic Keynesian mega fail.

  6. Gravatar of Mark A. Sadowski Mark A. Sadowski
    29. August 2013 at 14:21

    Doug M.,
    “I understand your rationale for NGDP, but the economics profession looks at RGDP.”

    RGDP growth is a poor measure for analysing policies that mainly impact aggregate demand (AD) such as monetary policy. RGDP growth is also affected by shocks to short run aggregate supply (AS), especially in a country as dependent on commodity exports as Australia.

    “Now conventional economic thinking would suggest that money operates with variable lags, so there is nothing inconsistent with seeing signs that growth is about to falter, cut rates (easing money) and the economy going into a recession nonetheless. With the power of easy money not kicking in until 1992.”

    Note however that by your own measurements the *real* 1-year rates (%) were the following in the fourth quarter of each year:


    So yes, real rates dropped in 1990 but they rose sharply in 1991 and, moreover, remained high thereafter. More importantly I estimate the long run real neutral rate is about 2.2% in Australia, so with the sole exception of 1990 monetary policy was tight throughout by this measure.

    If one is going to measure monetary policy stance by interest rates, real interest rates are better than nominal, and more importantly, changes in interest rates tell you absolutely nothing, otherwise lowering it from 78% to 20% should be expansionary, which is absolutely ridiculous.

    I talk about all this in much greater detail in the comments thread on Quiggin’s post.

  7. Gravatar of jknarr jknarr
    29. August 2013 at 14:33

    Interestingly, Australian wage growth had already decelerated hard in the mid-1980s — likely due to 3m real rates (less deflator) being jacked up to highs in 1985 (and likely crushed labor costs) — the real 3m rate remained the same (high) through the 1987-2000 period. Nominal rates fell very hard in the early 1990s alongside Australia flirting with 1% NGDP .

  8. Gravatar of flow5 flow5
    29. August 2013 at 14:34

    A clear distinction should be made between the temporary and the longer term effects of open market operations on the level of interest rates. To hold down the Fed Funds rate (and other rates through a key policy rate), the Manager of the Open Market Account puts through buy orders for T-Bills or other eligible securities sufficient to yield a net increase in free-gratis, commercial bank legal and excess reserves. The Fed acquires these earning assets by creating, new inter-bank demand deposits in the Federal Reserve Banks””that is by creating legal reserves at the disposal of the commercial banks.

    Assume the buy order is for T-Bills. The effect is to bid up their prices, reduce their discounts (interest rates) and add to free-gratis commercial bank legal and excess reserves. The incremental expansion of costless excess reserves increases the quantity of loanable “federal” funds thereby pegging or retarding the increase in the Fed Funds rate (policy rate), – but the longer term effects of these operations are to fuel the fires of inflation.

    An understanding of these temporary and longer term effects reveals why initiating a tight money policy temporarily brings about a continued upsurge in interest rates…but it has the longer term effect of bringing inflation, and interest rates, down (& vice versa).

    With interest rates at or near record lows it should be obvious that the FOMC is conducting a relatively restrictive monetary policy (i.e., rates-of-change in money flows-MVt less than 2 percent above the roc’s in real-output).

  9. Gravatar of ssumner ssumner
    29. August 2013 at 14:38

    jknarr, I don’t follow that.

    Joshua, No, you are confusing quarterly with the first half.

    Grim23, That seems plausible.

    Doug, You are confusing nominal and real rates. I was discussing nominal, as was Quiggin. They gets compared to NGDP, not RGDP.

  10. Gravatar of ssumner ssumner
    29. August 2013 at 14:45

    jknarr, What does 3M mean?

  11. Gravatar of jknarr jknarr
    29. August 2013 at 15:13

    Scott — three month/90d (ninety day) bill yields from FRED. Tried to link to the Aussie results, but

    may be better to see — GDP deflator from 1789, annually.

    The present value argument is, in short — tight money reduces NGDP. When NGDP slows down, top-line cash flows in the real economy become scarce.

    When real economy cash flow growth become scarce, the price of yield-bearing financial assets rises. Yields decline in bonds, and price-earnings rise in stocks.

    Hence tight money = lower economic growth = lower rates = higher financial asset prices (present value).

    Easy money = higher economic growth = higher rates = lower financial asset prices (present value).

    These simply guys conflate higher financial asset prices with easy money.

    Also, I somewhat object to treating the “Great Stagnation” as an operative assumption rather than a possible thesis. Take a look at US NGDP and RGDP since 1790 —

    At any time over the past 200 years, people could point at a handful of contemporaneous macro factors to make any wild case that economic growth was henceforth to be permanently below-trend — witchcraft, deforestation, slavery, women voting, socialism, industrialization, dust bowls, immigration, peak oil, global warming.

    They would have been wrong time and again — and are probably wrong now. So let’s first assume the GS is wrong, keep the eye on the ball to develop an effective monetary policy, and then see what happens. Until monetary conditions ease up considerably, the GS is pure justification for inertia and the status quo.

  12. Gravatar of Colin Docherty Colin Docherty
    29. August 2013 at 17:24

    Australia did some major banking deregulation in 1986 (long credited with our boom) and we floated our dollar in 1984.

    These may or may not be factors, I’m not an expert, just an observer (hence why I read your blog!) but just wanted to point that out in case it matters.

  13. Gravatar of Chun Chun
    29. August 2013 at 20:44

    Is there a survey of economists on this issue? If someone knows it, please provide references.

  14. Gravatar of Geoff Geoff
    29. August 2013 at 21:41

    “I had thought everyone agreed that the bigger the change in interest rates the LESS LIKELY it was due to the liquidity effect.”

    There are only individuals. There is no one “effect” with a name that explains the economy fully, other than purposeful activity.

    If a single individual asks for a drastically higher interest rate in response to a change in the money supply, and their own money balance, whereas someone else asks for a lower rate, but not as lower as the other’s is higher, in response to the same monetary changes, there is no one “effect” that explains why “average” interest rates rose. If a person changes their interest rate because of inflation expectations, you can’t deny this and ignore it by saying “the” effect for “the economy” was this or that.

  15. Gravatar of Lorenzo from Oz Lorenzo from Oz
    30. August 2013 at 01:40

    jknarr: Australian wage growth had already decelerated hard in the mid-1980s
    Australia had a very severe 1982-83 recession and a change of federal Government in March 1983. The Hawke-Keating Labor Government struck a deal with the unions which moderated wage growth in return for tax-and-expenditure benefits (i.e. an increased “social wage”). This was known as The Prices and Income Accord or The Accord for short.

    Given that Australia had an Arbitration System which set wages, wages could be managed in that fashion, if it played along, which it did. Especially after Justice Jim Staples was punished for not playing along.

    There followed major growth in employment which tended to further moderate (average) wage growth. So, a lot more going on than interest rates.

    The RBA adopted its present framework for monetary policy in 1993. Hence the way nominal indicators enter a new era thereafter.

  16. Gravatar of ssumner ssumner
    30. August 2013 at 06:53

    jknarr, This time is different . . .

    Seriously, I see things going on today that I have never seen before, even in equally severe recessions like 1982. Unemployment falling fairly fast when growth is 1.8%. When has that ever happened? Obviously you may be right, but I view the GS as the most likely hypothesis.

    Colin, Perhaps that pushed monetary policy off course. Stephen Kirchner wrote a paper on this episode, you might want to google it.

    Chun, I don’t know, but my impression is that most economists do equate low rates with easy money.

    Lorenzo. Good point.

  17. Gravatar of TheMoneyIllusion » Interest rates versus the base TheMoneyIllusion » Interest rates versus the base
    30. August 2013 at 07:49

    […] Another argument used in favor of the interest rate approach is that, out in the real world, people and policymakers think in terms of interest rates, not the base.  But that’s exactly the problem.  People think money has been easy since 2008 (even though according to Ben Bernanke’s criterion it’s been the tightest since Herbert Hoover was President), precisely because they’ve been taught that monetary policy is “best thought of” in terms of interest rates. They’ve been taught to look at not just a poor indicator, but one that is actually negatively correlated with the actual stance of monetary policy.  A poorly informed public will make bad public policy decisions.  And not just the public, even economists are confused. […]

  18. Gravatar of TheMoneyIllusion » Real interest rates are not much better TheMoneyIllusion » Real interest rates are not much better
    31. August 2013 at 10:12

    […] think this can be fixed by looking at real interest rates.  But that’s false.  Soon after I criticized a recent post by John Quiggin, he added a couple more paragraphs, and shifted his argument from […]

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