The dead horse I’m beating is very much alive

Lots of people tell me I’m beating a dead horse. The profession knows that low interest rates don’t equate to easy money. You can find dozens of quotes from eminent economists attesting to this fact:

“Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.  .  .  . After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.”(Milton Friedman, 1997)

 “It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.”  (Frederic Mishkin, 2007, p. 606)

The argument that current monetary policy in Japan is in fact quite accommodative rests largely on the observation that interest rates are at a very low level. I do hope that readers who have gotten this far will be sufficiently familiar with monetary history not to take seriously any such claim based on the level of the nominal interest rate. One need only recall that nominal interest rates remained close to zero in many countries throughout the Great Depression, a period of massive monetary contraction and deflationary pressure. In short, low nominal interest rates may just as well be a sign of expected deflation and monetary tightness as of monetary ease. (Ben Bernanke, 1999)

But then why do we continue to see prestigious outlets such as the Financial Times saying the following:

Unlike many on America’s left, I’ve always been sceptical that ultra-low interest rates make things easier for the poor. Keeping rates too low for too long encourages speculation and debt bubbles. When they burst, they always hurt those on low incomes the most, as we witnessed during the 2008 financial crisis.

And yet for years, progressives have argued that loose monetary policy and low interest rates are necessary to promote employment, particularly at the lower end of the socio-economic ladder.

The second paragraph is a complete non-sequitur with the first. We don’t have low rates due to a “loose” monetary policy. Interest rates tell us nothing useful about the stance of monetary policy.

Can someone explain to me why people keep saying things like this if the correct view is all so “well known”? Why does this keep happening? And how can it be stopped?

The beatings will continue until the horse is completely dead.


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36 Responses to “The dead horse I’m beating is very much alive”

  1. Gravatar of Rajat Rajat
    3. October 2021 at 15:07

    I’ve never thought much of Rana Foroohar. Frankly, there are far too many people at the FT who shouldn’t be there. I’ve read similar things from Matt Stoller, a left-wing antitrust academic. It’s tied up with a view that declining nominal interest rates are associated with rising asset prices and relying on higher asset prices to boost private spending is a less preferable means of achieving maximum output & employment than more government spending, MMT-style. But neither of these people are in any sense macroeconomists, or even economists. If your definition of a ‘horse’ is every over-rated op-ed writer or fund manager or crypto currency-holder, then you will be flogging on your deathbed.

  2. Gravatar of Market Fiscalist Market Fiscalist
    3. October 2021 at 15:48

    I think most economists accept the concept that ‘low interest rates’ mean low compared to the optimum rate.

    Assuming the FT guy holds that view then the quote doesn’t really seem out-of-line with your views.

    In the first paragraph he says that if interest rates are held low (I assume compared to his idea of what the optimum rate should be ) then bad things will happen.

    In the second he appears to argue against progressives who think that holding interest rates below the optimum is a good idea.

    This all begs the question of what is the optimum rate – but other than that I don’t see anything obviously wrong with the way he states things.

  3. Gravatar of marcus nunes marcus nunes
    4. October 2021 at 04:52

    Just like the name “Gillette” became the name that defines razor, interest rates became the “identifier” of the stance of monetary policy. While the first is harmless, the second is “dangerous”.
    And you don´t even need to mention “interest rate”, actual or “neutral” to know if mon pol is expansionary, contractionary or stable!
    https://marcusnunes.substack.com/p/macroeconomic-patterns-and-stories

  4. Gravatar of Todd Ramsey Todd Ramsey
    4. October 2021 at 05:07

    Scott-

    Is our public dialog about “interest rates” muddled by a failure to distinguish between short and long term maturities?

    Are low short-term rates correlated with easy money, and low long-term rates correlated with tight money?

  5. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. October 2021 at 05:19

    Interest rates are determined by the supply of, and demand for, loanable funds. You simultaneously add to new supply, new money through debt monetization, while decreasing old demand, taking securities off the market via open market operations of the buying type,.

    At the same time private sector demand is diminished due to the deceleration in velocity, or the impoundment of monetary savings, sterilization via the remuneration of IBDDs, all of which reduces AD.

    Money products in conjunction with the remuneration of IBDDs, decrease the real rate of interest while savings products increase the real rate of interest.

  6. Gravatar of Sven Sven
    4. October 2021 at 06:30

    Prof Sumner,

    Real interest rates are determined by supply and demand of loanable funds. Let’s call this rate the natural rate of interest. Supply of loanable funds is determined by savings and the demand for loanable funds is determined by credit(borrowing) demand.
    And monetary policy by increasing and decreasing loanable funds manipulates credit demand.
    After having put the mechanism in this way, we can argue about the level of interest rate and monetary policy.
    If natural interest rate is 5% and central bank lowers it to 2% this might be called a loose monetary policy. If central bank raise it to 8% this might be called a tight monetary policy. Since the optimal rate is perceived at 5%, the levels below and above that rate would be considered low and high.

    However, if the natural rate of interest falls to zero by itself, people might consider this rate is low and attributes the cause for it the loose monetary policy. However, this does not necessarily mean the monetarily policy is loose.

    “Can someone explain to me why people keep saying things like this if the correct view is all so “well known”? Why does this keep happening? And how can it be stopped?”

    I think the main problem here is not you try to beat the dead horse. The main problem is you view the ultra low interest rates as acceptable if not normal. However, reasonable people who question things at different perspectives do not accept the current paradigm as it is. The fundamental problem is ultra low interest rates and it is not about monetary policy. It is about global savings glut.
    You just focus on monetary policy with a tunnel vision. There are other things in economy that need to considered for a sound analysis. Monetary policy will not solve the existing problems in the long run. And your fight, unfortunately, will not end at any reasonable time. It will only end when interest rates go up and remain at an optimal level by the reduction of savings.

    P.S. It was not monetary policy that ended the Great Depression. It was world war II and subsequent fiscal policies both high tax rates and high level of spending.

  7. Gravatar of Michael Rulle Michael Rulle
    4. October 2021 at 06:45

    First of all monetary theory is hard. It took you most of your career to reach your current views. But here are some anecdotal reasons for the Ft and WSJ views.

    I cannot remember when interest rates were not perceived as the determinant of tight or loose money. Perhaps because it appears correlated—-I.e., when was the last time interest rates were hiked by the Fed and it was viewed as loosening? Of course, that could be circular—-as it could be it appeared to be tightening but was actually loosening.

    But that seems rare.Volcker hiked rates, it was a tightening, we had a shortish double tap recession, and inflation dropped by 2/3rds. Maybe that is the source of these views.

    Once one factors in the supply and demand for money, it becomes easier to see a different view. Nowhere in Fed theory does it say that it should be targeting interest rates—or that interest rates are a determinant of inflation. It is supposed to be targeting inflation and employment. FT and WSJ rarely write explicitly in those terms.

    But, once again we have a correlation happening. Rates are low and were lowered, and inflation is rising. Of course we have supply side shortages apparently due to “supply chains” constrictions, while we seem to have increased demand for product—-that alone seems like “inflation”.

    At some point Powell will have to determine if the inflation path will stay high—-in which case he will have to tighten. What are the odds this will not be accompanied by a rate hike?

  8. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. October 2021 at 07:44

    re: “Volcker hiked rates, it was a tightening, we had a shortish double tap recession, and inflation dropped by 2/3rds.”

    The distributed lag effect of monetary flows hit at the same time as the Emergency Credit Controls program of March 14, 1980. Volcker, not knowing money from mud pie, then eased monetary policy. Again, due to his ignorance, when the “time bomb” hit, the widespread introduction of NOW accounts, this propelled N-gNp to 19.1% in the 1st qtr. of 1981. So, Volcker, not understanding lags, imposed reserve requirements on these accounts in April. That caused the 2nd recession.

  9. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    4. October 2021 at 07:55

    As Dr. Philip George says: “The velocity of money is a function of interest rates”

    As Dr. Philip George puts it: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”

    Three things changed the direction of velocity in 1981, the DIDMCA, which turned 38,000 financial intermediaries into banks (the CUs, MSBs, and S&Ls), the complete deregulation of interest rates (elimination of Reg. Q ceilings), and the FDIC raising deposit insurance from $40,000 to $100,000.

    Velocity was further reduced in 2008 when the FDIC raised deposit insurance from $100,000 to $unlimited, and the FED began to remunerate IBDDs (causing an interest rate inversion, in the borrow short to lend longer savings/investment paradigm).

  10. Gravatar of ssumner ssumner
    4. October 2021 at 08:13

    Market, There’s this perception that central banks have recently had a loose monetary policy, and that this explains high asset prices. ​False!

    Todd, No, neither short nor long term interest rates reflect the stance of monetary policy. For that you want to look at NGDP expectations.

    Sven, You said:

    “However, if the natural rate of interest falls to zero by itself, people might consider this rate is low and attributes the cause for it the loose monetary policy. However, this does not necessarily mean the monetarily policy is loose.”

    For once we agree.

  11. Gravatar of TGGP TGGP
    4. October 2021 at 08:18

    Is it that odd for the media to be out of step with academic economists? Per wikipedia, Foroohar’s highest degree appears to be a B.A. in English, and she’s spent her entire career as a journalist.

  12. Gravatar of Jeff Jeff
    4. October 2021 at 09:14

    Aren’t these simply differences in how people understand “tight” vs “loose”? What if one were to define “neutral” monetary policy as the state of affairs in which government intervention is minimized and the money supply is tweaked by no more than trifling amounts and gradual increments over time?

    A neutral monetary policy of this sort most likely would have resulted in a wave of defaults following the crisis of 2008. Instead, policymakers intervened on a massive scale to deploy new money (i.e., loose money) to plug the holes in the dike. This kind of bespoke money creation contravened most people’s sense of justice and depressed interest rates by creating a widespread perception that the economy was fake and rigged and that the day of reckoning was merely postponed.

  13. Gravatar of bill bill
    4. October 2021 at 09:56

    I also find his word “keeping” in this sentence “Keeping rates too low…” really annoying. Look at the times like 2008 and 2011 when the ECB experimented with “NOT keeping rates too low”

  14. Gravatar of Justin Justin
    4. October 2021 at 17:15

    The Financial Times may be prestigious, but their analysis of events has been horrible since the Great Recession. They’re just about the worst of that group of middle brow business papers.

    Back around 2012-2013 I tried to systematize the model they seemed to be using and it was just bizarre. Of course they couldn’t grasp the monetary offset, but they also said CBs had limited capacity to increase aggregate spending, or that if CBs stimulated too much, there’d be “ketchup bottle” inflation explosion, but little increase in AD. Basically suggesting that inflation is not primarily driven by AD, but just kinda goes up and down and we’re not sure why, but don’t make the inflation gods angry with too much QE or exotic policy. I think really, they didn’t know what they were talking about. Depressingly, very few people really get this stuff.

  15. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    5. October 2021 at 05:08

    re: “There’s this perception that central banks have recently had a loose monetary policy, and that this explains high asset prices. ​False!”

    “In July, the latest month in the Atlanta Fed’s calculations, median home prices were $342,350, up 23% from the year before. Median incomes were $67,031, up a tiny 3%, less than the current rate of inflation.”

  16. Gravatar of Patrick R Sullivan Patrick R Sullivan
    5. October 2021 at 09:25

    The error in reasoning is in thinking that interest rates are ‘the price(s) of money’. Which is not what interest rates are.

    They are the prices of RENTING money that belongs to someone else, for a limited amount of time. The prices of BUYING money are the goods and services you have to give up to get ownership of money.

    The two different prices often move in opposite directions, as they did spectacularly in the 1970s in the USA.

  17. Gravatar of Ray Lopez Ray Lopez
    5. October 2021 at 11:55

    SS: “Can someone explain to me why people keep saying things like this if the correct view is all so “well known”?” – because it’s true?

    Emperor Sumner seriously expects us to praise the clothes on his naked body? Any schoolchild knows if interest rates are low, it’s a sign of lack of demand that even the Fed cannot fix (the Fed follows the market). The solution? Let interest rates find their own level, even if it means zombie borrowers default. That’s the 19th century way and if it’s good enough for great-great-granddad it’s good enuf for me.

  18. Gravatar of Michael Sandifer Michael Sandifer
    5. October 2021 at 19:43

    It is also a mistake to think that interest rates affect stock prices. Common factors that influence interest rates also affect stock prices. The discount rate for the S&P 500 averages very close to the NGDP growth rate over time, with short-term divergences. Prominent finance models that explicitly include interest rates as factors in stock valuation are wrong, confusing correlation and causation.

    I’m also increasingly entertaining the view that the loanable funds market model is either wrong or is irrelevant when it comes to interest rate determination, and that expected NGDP growth and growth volitility is instead determinative. Some economists have thrown back of the envelope representative agent models at me, pointing to problems with such a view, but if I take the example of an actual economy with a single agent, say a farmer who doesn’t trade, it seems savings and investment are exactly the same thing, the rate of return will equal the economic growth rate.

  19. Gravatar of Michael Sandifer Michael Sandifer
    5. October 2021 at 19:46

    I meant to spell the word “volatility” correctly, and I should say that finance models that use interest rates in stock valuation can be useful, if it’s understood the relationship between interest rates and stock prices is correlational, not determinitive.

    And anyway, it’s only in the short-run that lower rates in a slower growth economy are associated with higher stock prices. In the long-run, a higher NGDP growth rate overwhelms the lower discount rate.

  20. Gravatar of postkey postkey
    6. October 2021 at 03:04

    “Basically suggesting that inflation is not primarily driven by AD, but just kinda goes up and down and we’re not sure why, . . . ”

    Not ‘monetary driven AD?

    “Monetarist theory, which came to dominate economic thinking in the 1980s and the decades that followed, holds that rapid money supply growth is the cause of inflation.  The theory, however, fails an actual test of the available evidence.  In our review of 47 countries, generally from 1960 forward, we found that more often than not high inflation does not follow rapid money supply growth, and in contrast to this, high inflation has occurred frequently when it has not been preceded by rapid money supply growth.“
    https://www.ineteconomics.org/perspectives/blog/rapid-money-supply-growth-does-not-cause-inflation

  21. Gravatar of Todd Ramsey Todd Ramsey
    6. October 2021 at 05:30

    I know it’s just prices, not output, but is the TIPS spread the best indicator of predicted NGDP growth we currently have? Not including equity markets.

    Is the Hypermind market thick enough to be useful?

  22. Gravatar of Sven Sven
    6. October 2021 at 06:32

    Prof. Sumner,

    What we disagree is actually theory, not the policy. You believe in a fundamentally flawed monetary theory. I think we mostly agree on short-term monetary policy. However, I believe it is unsustainable in the long term.

  23. Gravatar of Sven Sven
    6. October 2021 at 06:47

    Spencer Bradley Hall,

    Velocity falls with two determinants. Economic growth and falling interest rate. And when interest rate reaches zero lower bound the connection with interest rate disappears. Velocity falls indefinitely as response to money supply growth in this situation.

  24. Gravatar of ssumner ssumner
    6. October 2021 at 08:46

    Todd, The best forecast is a composite indicator that includes TIPS spreads and other indicators as well.

  25. Gravatar of David S David S
    6. October 2021 at 10:29

    Scott, I’ve been mulling over a really crazy thought experiment that’s inspired by material chapters 12 and 15 in your book. Here’s how it works:

    The Fed goes bonkers and decides to do the following:

    1. Makes public statements that inflation must be reduced to less than 2%. They repeat this statement frequently.
    2. All QE is stopped immediately–screw tapering or anything like that.
    3. Funds rate is jacked up over the course of 18 months from 0.10 to something in the 3%or 4% neighborhood.
    4. All screaming from politicians, stockbrokers, economists, and journalists is ignored.

    What happens to the economy over the next few years as this bonkers regime is maintained? My guess is a steep plunge in NGDP growth and high unemployment for a few years, but can things claw back to normal once the sub 2% inflation rate is maintained and enforced rigorously?
    Or would things be worse?

    Again, I emphasize that this all a crazy thought experiment and I don’t want any of this to ever happen, but I’m trying to see if I understand the power that a Central Bank can wield over the economy. This is based partly on your description of Japan’s Central Bank position and rate actions from 1994ish to 2013.

  26. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. October 2021 at 10:51

    Latest Atlanta gdpnow estimate: 1.3 percent — October 5, 2021

    That shows that unlike during the monetization of time deposits, during 1961 and 1981, where velocity increased after an injection of new money, today we have the opposite scenario.

    So what causes Money Velocity to fall?

    I.e., savings are impounded in bank-held savings and dissipated in financial investment, rather than real investment.

  27. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. October 2021 at 10:55

    re: ” The theory, however, fails an actual test of the available evidence.”

    Dead wrong. There’s a perfect correlation between long-term monetary flows, volume times transaction’s velocity, and the price-level. Just because the jackass econometric boys don’t know it doesn’t mean it’s unfounded.

  28. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. October 2021 at 13:47

    sven: “And when interest rate reaches zero lower bound the connection with interest rate disappears.”

    Good point. So, the “Rstar”—Wicksell’s neutral or natural interest rate at which investment fully absorbs saving at full employment, is bogus.

  29. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    6. October 2021 at 14:25

    The definition of inflation has changed. That’s the 1970’s difference between commercial bank credit, and today’s Reserve Bank credit.

  30. Gravatar of postkey postkey
    6. October 2021 at 23:36

    “There’s a perfect correlation between long-term monetary flows, volume times transaction’s velocity, and the price-level.”

    Then show it! NB the correlation coefficient has to equal 1!

  31. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. October 2021 at 05:38

    That’s what Joe Granville did, and look where that got him. “after successfully predicting a stock market top in January 1981, Granville’s picture appeared on the front page of the New York Times.”

    You probably weren’t around back then. You have to protect your trades.

  32. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. October 2021 at 05:40

    As my good friend told me: Dr. Leland J. Pritchard, in his letter 9/8/81: “you may have a predictive device nobody has hit on yet”.

  33. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. October 2021 at 05:56

    Inflation is a monetary phenomenon. Inflation simply results from a long-term excessive flow of money relative to the volume of real output of goods and services offered in the markets.

    Inflation occurs when there is a chronic across-the-board increase in prices. or, looking at the other side of the coin, depreciation of money. Inflation is not a temporary increase in the price level, nor a long-term increase in any particular prices.

    The evidence of inflation cannot be conclusively deduced from the monthly changes in the price indices. From the standpoint of the economy no overall index, or average of all prices, exists.

    Therefore, no single figure exists which represents the value of money. Prices reflect, in only a marginal amount, the inflation that took place in real estate, Cryptos, etc. The price indices are passive indicators; of the average change; of a group of prices. They do not reveal why prices rise or fall.

    Only price increases generated by demand, irrespective of changes in supply, provide evidence of inflation. There must be an increase in aggregate monetary purchasing power which can come about only as a consequence of an increase in the volume and/or transactions’ velocity of money.

    The volume of money flows must expand sufficiently to push prices, up, irrespective of the volume of financial transactions, the exchange value of the U.S. $ (reflected in FX indexes and currency pairs), and the flow of goods and services into the market economy.

  34. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    7. October 2021 at 06:41

    See: New Measures Used to Gauge Money supply WSJ 6/28/83. Neither William Barnett nor Paul Spindt, nor the St. Louis Fed’s technical staff in 2008:

    “Although the evidence is mixed, the MSI (monetary services index), overall suggest that monetary policy *WAS ACCOMMODATIVE* before the financial crisis when judged in terms of liquidity;

    …use accurate money flow metrics reflecting changes to AD.

    See: Fed Points

    https://www.newyorkfed.org/aboutthefed/fedpoint/fed49.html

    “Following the introduction of NOW accounts nationally in 1981, however, the relationship between M1 growth and measures of economic activity, such as Gross Domestic Product, broke down.

    Chairman Jerome Powell errored:

    “This change means that savings deposits have had a similar regulatory definition and the same liquidity characteristics as the “TRANSACTION ACCOUNTS” reported as “Other checkable deposits” on the H.6 statistical release since the change to Regulation D.”

    WSJ 6/28/1983: “The experimental measures are designed to resolve some of the confusion by isolating money intended for spending, from the money held as savings. The distinction is important because only money that is spent-so-called “true money” – influences prices and inflation”

    I.e., Steve Hanke is wrong: “In fact, if the money supply had been measured correctly by a Divisia metric, Chairman Volcker would have realized that the Fed was slamming on the brakes from 1978 until early 1982.”

  35. Gravatar of postkey postkey
    7. October 2021 at 06:55

    So no empirical evidence.

    Just the usual B.S.!

  36. Gravatar of ssumner ssumner
    7. October 2021 at 08:52

    David, Yes, that policy might well cause a deep recession.

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