Don’t ease monetary policy; cut rates instead

David Beckworth directed me to a new piece by Jeffrey Frankel:

A Trade War is No Reason to Ease Monetary Policy

A trade war is a negative supply shock, and central banks cannot counteract the negative effects of current policies on real incomes in the United States, the United Kingdom, and many other countries. Only voters can do that

He’s right.  A supply shock does not provide a reason to ease monetary policy, as it’s an adverse supply shock.  The Fed should not boost AD to offset a supply shock.  Rather, it should prevent AD growth from changing by keeping interest rates at the Wicksellian equilibrium rate.  Because a trade war will generally reduce the equilibrium interest rate, the Fed should cut rates to avoid changing monetary policy.

PS.  Some (most?) economists believe that cutting interest rates is equivalent to easing monetary policy.  I find that horrifying.

PPS.  I was not able to read the entire Frankel piece, as it’s limited to subscribers.  But the opening bit is 100% correct.



31 Responses to “Don’t ease monetary policy; cut rates instead”

  1. Gravatar of Michael Sandifer Michael Sandifer
    10. June 2019 at 08:45


    This highlights something that frustrates me as a non-economist. Economists are sometimes very sloppy with their language, which causes much unnecessary confusion. Your explanation here is very clear. I wish more economists would use a bit more technical language more often to avoid such confusion.

    Also, let’s not put too much weight on semantics, since there are so many mistakes made anyway, and much depends on context.

    I can say the Fed needs to loosen policy in response to supply shocks after they’ve already let r* fall. Or, I can say they need to lower rates to keep policy neutral, contemporaneous with negative supply shocks.

  2. Gravatar of Michael Sandifer Michael Sandifer
    10. June 2019 at 09:00

    I should clarify and say that pure English is a relatively difficult way to express these ideas, so we shouldn’t put too much emphasis on semantics among the informed. But, we should appeal to more precise, technical language more often.

  3. Gravatar of Effem Effem
    10. June 2019 at 10:15

    So raise inflation in the event of a trade war? Yup, voters will love that. This is a great way to risk the loss of Fed independence.

  4. Gravatar of Michael Sandifer Michael Sandifer
    10. June 2019 at 10:45


    It’s either higher inflation, or fewer jobs due to sticky wages. Which do you think voters will prefer?

  5. Gravatar of South African Fan South African Fan
    10. June 2019 at 11:37

    What luck to have been a follower of this blog for the past decade.
    I am not an economist but thanks to posts like this my understanding of macro seems far superior to the nonsense the press generally attributes to respected economists.

  6. Gravatar of ssumner ssumner
    10. June 2019 at 12:05

    Effem, You said:

    “Yup, voters will love that.”

    You are correct. Voters liked the stagflation of early 2008 way more than the deflation of late 2008.

  7. Gravatar of Justin Justin
    10. June 2019 at 12:13


    Somewhat related question.

    Is there ever any good reason, in your view, for the Fed to leave the Fed Funds rate unchanged when the curve is quite inverted, as it is doing now? Most of the rest of the curve seems flat/upward sloping (looking at 2yr, 5yr and 10yr treasuries). Aside from 5yr breakevens, this seems to me to be a strong market signal for the Fed to cut.

    Or perhaps put another way, would you ever expect significantly inverted yield curves if the Fed abandoned interest rate targeting and did NGDPLT instead?

  8. Gravatar of Philo Philo
    10. June 2019 at 14:00

    There is never a reason to ease monetary policy. The monetary authority should adopt the optimal policy and then never deviate from it, neither easing nor tightening.

  9. Gravatar of Benjamin Cole Benjamin Cole
    10. June 2019 at 15:41

    A baseball analogy usually serves.

    Is the baseball manager who watches his starting pitcher get bombed for seven runs in the sixth inning really doing nothing?

    Actually, he has changed his policy. The manager’s policy should be to limit runs to a reasonable level.

    The manager, to maintain his policy, should bring in a relief pitcher.

    A baseball manager is never doing nothing. So it is for central banks.

    Scott Sumner idea of daily central bank adjustments based on market signals is very worthy.

  10. Gravatar of George Selgin George Selgin
    10. June 2019 at 18:50

    Right on, Scott.

  11. Gravatar of Benjamin Cole Benjamin Cole
    10. June 2019 at 19:07

    Interesting question: How has China run for 40 years without a recession?

    Even if Westerners do not wish to emulate the Sio model, might there be some clues therein?

    Add on: It seems like in the West we are constantly on seat-edge that a recession may be pending. This is the best we can do?

  12. Gravatar of Trevor Adcock Trevor Adcock
    10. June 2019 at 23:37

    Ben, you don’t really trust the Chinese unemployment rate figures do you? Do they even count what is happening in the vast rural part of the economy? Your denial of the long run neutrality of money is comical at best.

  13. Gravatar of Benjamin Cole Benjamin Cole
    11. June 2019 at 01:52

    Trevor Adcock: I will readily concede that since President XI has declared the purpose of media in China is to disseminate the views of the Communist Party of China, many “China-watchers” are groping in the dark. Me, too. I talk to smart people in Hong Kong, and read what I can.

    But in general, my guess is the China economy is growing, roughly as indicated—-we see sophisticated Western investors, such as BlackRock, the world’s largest price investor, taking positions in China. Cruise lines are building ships to serve the China trade. Sino tourists are crawling all over Bangkok and Thai islands. Remember, the PBoC is a growth-oriented central bank. They have a rough 3% inflation target, and if it goes to 4% that is no big deal. They are not hamstrung by moral hazard when propping up Sino banks. They keep the banks running and lending.

    A side note: Japan appears ready to go ahead with an increase in the national sales tax to 10% from 8%. I get it, better to tax consumption than income. But always? There seems to be a glut of capital in Japan, but aggregate demand is weak. At some point, does taking more medicine…just mean taking more medicine?

  14. Gravatar of Benjamin Cole Benjamin Cole
    11. June 2019 at 01:55

    Trevor–Money may be neutral in the long run—-but how many decades you got?

    The Great Depression lasted for a while—and perhaps was only interrupted by WWII. In Japan they stranged the Great Depression in the crib by going to helicopter drops.

    The Great Recession was no walk in the park.

  15. Gravatar of Christian List Christian List
    11. June 2019 at 03:52

    Is it time for my “So-Trump-was-right!?”-comment again, or is it too early?

  16. Gravatar of Justin Justin
    11. June 2019 at 05:31


    The question about China’s lack of recessions is interesting… after checking, it seems that a few other Asian nations were relatively recession resistant during their developing phases, if not as resilient as China.

    South Korea, for example, appears to have had only had one year of recession between 1961 and 1997, and Japan seems to have only had one between 1956 and 1991.

    Perhaps there is enough momentum from the process of catching up that, so long as your institutions are decent enough, there is a very low risk of recession. The business cycle becomes a more prominent feature of the economy once catch-up momentum has ended.

  17. Gravatar of Brian Donohue Brian Donohue
    11. June 2019 at 06:56

    10-year Treasury is at 2.15%. Don’t overthink this.

  18. Gravatar of Christian List Christian List
    11. June 2019 at 09:31

    There you go, from today, headlines from big media outlets:

    Trump Renews Fed Attack, Saying Interest Rates Way Too High.

    Trump hits Fed over high interest rates: ‘They don’t have a clue!’

    He is right. He doesn’t know why, he doesn’t know how, and his theories are really simple, to put it mildly.

    But funnily enough, his conclusion on monetary policy is right in the end. And this since months. I think that’s super funny. Scott, where is your humor?

  19. Gravatar of Cameron Blank Cameron Blank
    11. June 2019 at 09:39

    Christian List,

    “But funnily enough, his conclusion on monetary policy is right in the end.”

    If he was right he would try to boost the supply side of economy instead of hurting it through trade policy. Most of the fall in yields recently is directly related to his trade policy. Yields will rise when he capitulates on trade matters and fall when he “gets tough”.

    Also, attacking the fed makes it more difficult for them to lower rates for obvious optics reasons.

  20. Gravatar of Cameron Blank Cameron Blank
    11. June 2019 at 09:45

    Benjamin Cole,

    The baseball analogy is a good one, although even it doesn’t go far enough as managers only have so many pitchers whereas there is no effective limit to how much the fed funds rate can be changed. And even base money previously had to change to keep the fed funds rate constant!

    When in comes to monetary policy inaction IS action.

  21. Gravatar of ssumner ssumner
    11. June 2019 at 09:53

    Justin, It might be inverted because NGDP growth is expected to slow from a pace that was inconsistent with the central bank’s target.

    Christian, You keep making a fool of yourself, showing that you are in way over your head. Just stop trying to defend Trump.

  22. Gravatar of Christian List Christian List
    11. June 2019 at 11:39


    Most of the fall in yields recently is directly related to his trade policy.

    I know all that. He could do that if he wanted to and if he knew it. But he doesn’t know it and he doesn’t want to. But that doesn’t mean he’s wrong about the specific issue which simply is: all else unchanged, are interest rates by the FED correct right now or not? He says that they are not, which is correct.

    I guess you could call Trump a pyromaniac who starts one fire after another and then blames the FED for being arsonists. But that doesn’t mean he’s wrong about the fact, that there is a fire and that the FED could really help right now.


    no, it’s not that easy. He’s right about the specific issue, which is super funny.

    One can always find explanations why certain politicians are still wrong because they do not pay attention to specific details. Or because they have no expert knowledge but a very simple mindset. Or because their conclusion is correct, but their path leading to the conclusion is wrong.

    Trump is very extreme in that sense. But if you generalize that, politicians will never be right because these criteria are almost always partially true. No matter how you turn it, at the end of the day, Trump is still right about the specific issue.

  23. Gravatar of Benjamin Cole Benjamin Cole
    12. June 2019 at 00:43


    I think that is right, that a rapidly growing and developing economy is less recession-prone.

    I think the People’s Bank of China has played a role in the no-recession China, as well as some targeted liberalization, and some smart state-planning (I do not know how infrastructure gets built except with state planning, or at least a state green-light).

    The Belt-and-Road Initiative, if successful, will be another example of state-planning that aids Sino GDP growth.

    I am not advocating the Sino model for the US. I am wondering if there are lessons in 40-year winning streak for Westerners to ponder.

    The Western attitude, that China is only successful to the extent they adopt our ideas regarding economic development, strikes me as hubris.

  24. Gravatar of ssumner ssumner
    12. June 2019 at 08:36

    Christian, No, it’s not right say say “stocks should go down” 100 times in a row, as they go up, and then claim you are right the day they finally fall. That’s just stupid.

    Markets go up and down, including both stocks and interest rates. If one constantly advocates one specific direction of change, then one will be “right” when markets go in that direction and wrong when they don’t. Don’t be so stupid.

  25. Gravatar of Paul Paul
    12. June 2019 at 09:33

    I think you can reasonably see how it would be frustrating how often you critique the view that interest rates matter a lot for monetary transmission, but then tell us that keeping the interest rate still while the natural rate falls is “tight money”.

  26. Gravatar of Christian List Christian List
    12. June 2019 at 12:25


    I get your general point, which is not wrong. Trump is a bit like a broken clock that is right twice a day, but not entirely, because you are also comparing apples and oranges. Predicting something and demanding a policy are two different things.

    I remember Trump’s very vocal demands around autumn/winter and now, that is at times when it was important. Not to mention that the FED is quite often wrong (and then usually they are too tight), and they are especially then wrong, when they need to be right the most (and then they are ultra-tight), which makes Trump more right again. His general feeling is not wrong: When the FED is wrong, they are usually tight, uptight, ultra-tight.

    You minus TDS and you would admit it.

  27. Gravatar of ssumner ssumner
    13. June 2019 at 09:37

    Paul, It’s not tight money because interest rates matter for the transmission mechanism. Suppose they targeted the price of zinc. If the target price were above the equilibrium price of zinc, you’d have tight money., But that doesn’t mean that zinc would be playing a big role in the transmission mechanism.

    Christian, This isn’t complicated. If you always favor lower rates then you’ll be right when rates fall and wrong when they rise (as in 2018). How hard is that to understand?

  28. Gravatar of Brian Donohue Brian Donohue
    13. June 2019 at 12:41

    Update: 10-year Treasury at 2.09%. Data dependent, blah blah blah.

  29. Gravatar of Paul Paul
    13. June 2019 at 13:42


    So when the price of gold was the target before 1934, gold did not play a big role in the transmission mechanism? Would that not be the opposite of the position you took in the Midas Paradox?

    Besides, the Fed doesn’t target the natural rate of interest, they target inflation. So you can possibly say if inflation is below the target, then we have “tight money”, but it does not automatically follow that expansionary monetary policy is sufficient to bring about a recovery.

    Market monetarists confuse people when they say things like “the Fed should have cut rates in mid-2008 to ease policy” but also say “lower rates are not easy money”, and then switch back and forth between referring to interest rates, the money supply, and NGDP as indicators.

  30. Gravatar of Christian List Christian List
    13. June 2019 at 13:46


    Thank you, I get your general idea. I just think it’s a matter of degrees. What would have happend if they FED stayed at low rates in 2018? I assume: not too much. What happened when they stayed at high rates during the Great Recession?

    So yes, I get it, permanent “low interest rate”-guys like Trump are not good, but the question is still a matter of degree: What kind of damage would a super-dove like Trump have been made during the last years, and what kind of damage did the FED do during the Great Recession, people who aren’t even extreme hawks (at least not on purpose). They even caused the Great Recession, if you will!

    And on a side note: Call yourself a raven not an owl. A raven stands for wisdom as well (but way more oriented on the future), and it also fits better to America than an owl. You are the American man of the future not of the past.

  31. Gravatar of Jeff Jeff
    17. June 2019 at 08:58

    A bit late to the party, but I want to chime in that Scott got this post 100 percent correct. Short, but clear and directly on point.

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