How do we know that money is getting looser?

We don’t know for certain, but the evidence points that way.

Ideally, we’d have a highly liquid NGDP futures market. Unfortunately, we are still in the Stone Age of macroeconomics. (Future generations will laugh at our ineptness, just as we laugh at 1930s and 1970s policymakers.)

Without the NGDP future market, I usually start with 5-year TIPS spreads, which have been rising during 2022. They might be distorted by rising oil prices, so then I look at 5-year, 5-year forward TIPS spreads, which have also been rising. They are not affected by commodity prices. Check that, they might be affected (I’ve never studied the issue), but they are not distorted by commodity prices, which follow something close to a random walk.

If you put a gun to my head, and forced me to come up with an argument that money is getting tighter, despite all of this evidence, here’s what I’d say:

The stance of monetary policy is not a single number; it’s a vector. There’s the 12-month expected NGDP growth rate, the expected NGDP growth rate from 12 to 24 months out, the expected NGDP growth rate from 24 to 36 months out, etc., etc.

It’s theoretically possible that near-term expected NGDP growth is slowing, despite rising TIPS spreads, while longer run expected NGDP growth is rising. It’s possible that short run money is getting tighter while long run money is getting looser. In the near term, the Ukraine supply shock might have caused inflation expectations to rise even as NGDP growth expectations fell.

But I like Occam’s Razor. The simplest explanation for what’s going on is that the Fed is gradually losing credibility, which means money is getting easier. That’s my current view.

PS. If you want a concrete example of a monetary policy change that would make money tighter in the short run and easier in the long run, consider what would happen if Japan pegged the yen to the dollar. Japanese interest rates would immediately rise to US levels, but inflation in Japan would move closer to US levels in the very long run.


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23 Responses to “How do we know that money is getting looser?”

  1. Gravatar of Matthias Matthias
    26. April 2022 at 22:01

    Scott, you bring up that hypothetical Yen/USD peg as an example from time to time. I like it.

    How would it’s impact moderate, if the market didn’t trust the peg for a while, and tested if? Just like the market didn’t trust the Swiss Frank peg to the Euro?

    How long for the interest rates etc to move like you predicted?

  2. Gravatar of MIchael Sandifer MIchael Sandifer
    26. April 2022 at 22:48

    The expected mean NGDP growth path has fallen 0.50% to 4.46% and 5 year inflation expectations are down 0.22% points, from the highs of the year. The mean expected NGDP growth path fell nearly 0.13% yesterday, alone. Treasury yields fell by a very similar magnitude yesterday, so monetary has tightened this year.

    The biggest tell is the stock market. The S&P 500 will fall a bit more than 10% further, if the expected mean NGDP growth path falls back to 4%.

    I’ve added some key indicators in the form of daily updated FRED graphs to my gdpforecast.com page, whicb features my market-based streaming mean expected NGDP forecast. I’m also looking at possibly developing a stablecoin based on the market based NGDP forecast tool.

  3. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    27. April 2022 at 06:57

    Spot on. The FED policy is indeed getting easier. Growth is set to accelerate unless the FED changes course. Money growth is too high. The money supply can never be properly managed by any attempt to control the cost of credit.

  4. Gravatar of ssumner ssumner
    27. April 2022 at 08:38

    Matthias, The lesson of Switzerland and Denmark is that markets will trust the peg if the central bank is sincere and they won’t trust it if the central bank is not sincere. So if they plan to renege on the peg, then it won’t work.

  5. Gravatar of ee ee
    28. April 2022 at 03:24

    Are the people making decisions at the fed performing worse than their predecessors? Or is this a novel situation? If the people are doing worse, what is it about the system that gets people there that is failing?

  6. Gravatar of William Peden William Peden
    28. April 2022 at 05:01

    Scott,

    It has occurred to me that there are two types of supply shocks:

    (1) Let YoY NGDP be 4% over 10 years. In year 10, Yellowstone Park has an eruption and RGDP growth falls from a 2% trend to 0% for year 10. Inflation becomes 4% rather than 2%.

    (2) Same as before, except instead of Yellowstone Park erupting, the Fed decides to raise NGDP growth to a -4% trend in Year 9, and then changes its mind and targets 8% in year 10. Since the economy is not in equilibrium in year 10, it’s not at the LRAS curve. However, since the SRAS curve is neither horizontal nor vertical, the increase in AD causes both higher RGDP growth and inflation in year 10.

    Here’s the problem: from the point of view of citizens, politicians, journalists etc., both of these will look very similar. There will be shortages in particular sectors. There will be stagflation, in that the economy is neither at full employment nor with a steady low rate of inflation.

    One of my many complaints about economic commentary, mainly by journalists/bloggers but also by economists who should know better, is that they have conflated these two types of inflation where the supply-side is a factor. Of course, there has been a bit of both in the past year. But I don’t see how one can have double-digit NGDP growth without rapid inflation, even if there is a negative AD shock beforehand:

    https://fred.stlouisfed.org/graph/?g=OCZC

  7. Gravatar of ssumner ssumner
    28. April 2022 at 05:28

    ee, Powell certainly has less expertise in monetary policy than did Yellen.

    William, I don’t follow this:

    “Same as before, except instead of Yellowstone Park erupting, the Fed decides to raise NGDP growth to a -4% trend in Year 9, and then changes its mind and targets 8% in year 10.”

    What do you mean raise growth to minus 4%?

  8. Gravatar of William Peden William Peden
    28. April 2022 at 09:10

    Sorry, that should be “change”!

  9. Gravatar of MIchael Sandifer MIchael Sandifer
    1. May 2022 at 08:51

    Scott,

    Just out of curiosity, since you don’t think a monetary tightening cycle began on January 3rd, as I do, why do you think the stock market is down this year? Is it due to lower real growth expectations alone? I don’t expect us to see the same relationship between inflation and real earnings we saw in the 70’s, when bracket creep(or gallup, actually) so distorted the market.

  10. Gravatar of ssumner ssumner
    1. May 2022 at 09:10

    Michael, Lots of factors. Covid in China, the Ukraine War, the high inflation. Stocks did poorly in the 1970s when NGDP was skyrocketing upwards.

  11. Gravatar of Michael Sandifer Michael Sandifer
    1. May 2022 at 15:53

    Scott,

    My model says NGDP is down this year, though still well above 3%, and inflation expectations have fallen some, but not as much as real growth expectations.

    As far as the 70s are concerned, nominal stock prices were flat while prices were down in real terms. That was due to bracket creep, which is not such a problem today.

  12. Gravatar of Michael Sandifer Michael Sandifer
    1. May 2022 at 15:54

    The above should say that NGDP growth expectations are still well above 4%.

  13. Gravatar of Michael Sandifer Michael Sandifer
    1. May 2022 at 16:16

    I’m sorry, but meant to say that inflation expectations are up year-to-date, but NGDP is down, reflecting lower real growth expectations.

  14. Gravatar of Bolo man Bolo man
    2. May 2022 at 03:13

    Occam rasor show USD as a internaly almost valueless currency. QE, inflation, huge debt – all of this is inevitable end od USD as we all knkow. No wonder and no fear – GESARA knocks the door. WG1WGA…

  15. Gravatar of Bolo man Bolo man
    2. May 2022 at 03:15

    Occam rasor show USD as a internaly almost valueless currency. QE, inflation, huge debt – all of this is inevitable end of USD as we all know. No wonder and no fear – GESARA knocks the door. WG1WGA…

  16. Gravatar of Ricardo Ricardo
    2. May 2022 at 22:16

    Speaking of credibility, here is Buffet today talking about BTC.
    He essentially says he doesn’t like it, because it undermines the Federal Reserve.

    https://www.newswars.com/billionaires-bitter-on-bitcoin-its-evil-because-it-undermines-the-federal-reserve/

    But he misses the point entirely. We don’t want the Fed anymore, hence the adoption of currency. The point of this entire movement, is to fundamentally destroy the Federal reserve, and to remove the federal government away from controlling the supply. The blockchain community is a libertarian movement.

    It’s quite funny to see these billionaires panicking. They know they cannot stop it. Sure, they can issue a CBDC coin, but they cannot force people to use it. Just look at nigeria. Its a perfect case study. The only way to stop a public blockchain is to shut down all electricity.

    Good luck with that.

  17. Gravatar of Michael Sandifer Michael Sandifer
    3. May 2022 at 05:27

    Ricardo,

    There’s zero chance Bitcoin makes central banks obsolete. I want to experiment with true free banking, so I do sympathize, but Bitcoin will never be a widely accepted currency.

    I’m working on plans for an NGDPLT-based stablecoin for Dollars which, I hope, will at least one day provide a cheap, convenient alternative to international Dollar exchange. It’s a long, long, complicated road though.

  18. Gravatar of Nick S Nick S
    5. May 2022 at 03:26

    Scott,

    Not sure I understand your logic here. There is much more evidence to suggest money is tight including…

    -High utilization of Fed reverse repo facility. If money was looser, why does $1.7 trillion and change consistently parked back at the Fed overnight by money market funds?
    -Increasing repo fails
    -Spot yield curve inversions (toward long end). If money was getting looser, why is there still increased demand for treasuries even with a hawkish Fed? Answer… because banks create money through loan growth (the Fed only controls reserves) and that loan growth is tepid. Banks would rather invest in these safe assets because they have no risk adjusted appetite to make loans.
    -Forward yield curve inversion (2s10s inverted ~3m out). Eurodollar future markets are forecasting a rate cut in a year or so.
    -Recent dollar strength. If money is looser, why has the dollar rallied dramatically in the last few months?

  19. Gravatar of c8to c8to
    5. May 2022 at 16:31

    I think you’re right about looking back at the seventies stagflation and future will look back on us.

    I think it will be something new again – something like paying for the sins of the past 20 years of alternate loose and then tight money.

    I see low labour forcé participation , at the same time as inflation, at the same time as employers can’t find good hires and no real growth opportunities for 2-5 years .

    The great checkout – workers check out and investors do also – high cash (or whatever M variable it is) balances and the real economy just gets real sluggish or even retracts. Animal spirits when the stock market goes up people are optimistic the reverse it’s doom and gloom everywhere.

    It’s going to suck – blue state bankruptcies probably.

    I’m not technical enough to have a good explanation or data for this – the best I can say is the hangover after the party.

  20. Gravatar of ssumner ssumner
    5. May 2022 at 19:49

    Nick, I focus on NGDP growth and TIPS spreads.

  21. Gravatar of Nick S Nick S
    6. May 2022 at 19:40

    Scott- Are you adverse to analyzing or considering data other than NGDP and TIPS spreads (both of which are dependent on a subjective index measure) to make assessments about economic growth? I’m not trying to be snarky here, but honestly trying to understand your logic, so if you could please clarify, I’d greatly appreciate it.

    Why did NGDP not grow at the rate it is now post GFC after the Fed supposedly adopted the same “loose” monetary policy it did during covid?

    My assertion is because the Fed has little influence. The inflation now is the result of a supply shock and government deficit spending.

    Also, this is besides the point, but 5yr TIPS spreads are ~3%. Nothing particularly alarming.

    If prices rise because of reasons that are non-monetary, why should the fed attempt to bring prices down using monetary forces (even though they aren’t capable of doing so because they don’t create money, they create reserves. Banks creates money via lending).

    I’d really appreciate a response other than “I’ve written books on this” or “I only focus on xyz.” Otherwise, what is the point of this blog. Economics is stuck in the Stone Age because people are not willing to engage in this type of debate.

  22. Gravatar of ssumner ssumner
    7. May 2022 at 20:46

    Nick, You said:

    “Why did NGDP not grow at the rate it is now post GFC after the Fed supposedly adopted the same “loose” monetary policy it did during covid?”

    Yes, “supposedly”. I’ve spend the past 13 years showing that policy was actually tight during the GFC and recovery.

    “My assertion is because the Fed has little influence.”

    I strongly disagree (as do the markets). Monetary policy drives AD.

    “If prices rise because of reasons that are non-monetary, why should the fed attempt to bring prices down using monetary forces (even though they aren’t capable of doing so because they don’t create money, they create reserves. Banks creates money via lending).”

    Are you making a substantive point, or just obsessing over terminology? Money can be defined in many ways. The Fed controls the monetary base. That’s enough to control AD. Surely you aren’t advocating MMT?

  23. Gravatar of Michael Sandifer Michael Sandifer
    8. May 2022 at 08:24

    Single month changes in data points obviously do not a trend make, but EPOP fell last month for the first time since late 2020. Also, the decline in the unemployment rate has been flatlining for at least 2 months.

    This is consistent with the claim that monetary policy has been tightening this year, though with the right model regarding stock prices, one would already have known this.

    Changes in stock prices reflect changes in NGDP growth expectations, to the degree factors that more specifically affect stock prices are absent. This isn’t the 1970s with the bracket creep problem, so the fact that the broad indexes are down means that NGDP growth expectations have been falling.

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