The dual relationship between the interest rate and QE debates
The recent debate between Keynesians and NeoFisherians has received a lot of attention. Keynesians argue that a low interest rate policy is inflationary, whereas NeoFisherians argue that a low interest rate policy is disinflationary. I say they are both wrong, as interest rates are not “policy” at all. Both sides are reasoning from a price change.
It’s less well known that this debate has a “dual” or a parallel debate involving quantities. Just as one should never reason from a price change, one should also never reason from a quantity change. An increase in quantity might be associated with lower or higher prices, depending on whether it is caused by a supply or demand shift.
Suppose that in 2019 I told you that the monetary base was likely to double over the next 12 months. How would that forecast influence your expectations for inflation in 2020? Would you raise or lower your inflation forecast?
Would your answer depend on whether the doubling of the base occurred in the US or in Zimbabwe?
If it were in the US, would it matter if the forecast occurred in 1979 or 2019?
If the QE forecast had occurred in Zimbabwe, I’d expect hyperinflation. Zimbabwe is not the sort of country to engage in American-style QE, as it doesn’t face a zero bound problem.
If the forecast occurred in the US in 2019, I’d probably expect lower inflation in 2020. I’d assume the Fed was doing QE to counter a deflationary shock to the economy, perhaps from a trade war. (I wouldn’t have expected Covid-19.)
If the forecast had occurred in the US in 1979, I’d probably expect higher inflation, as soaring inflation was on everyone’s mind and there was absolutely no thought of “liquidity traps”.
Thus the question “Is QE likely to lead to higher inflation?” is every bit as nonsensical as the question “Are lower interest rates likely to lead to higher inflation?” Without context, it’s a meaningless question.
I sometimes read the economic debate on twitter but have no desire to jump in. My view of interest rates and QE is so radically different from the rest of the profession that I would hardly even know how to converse with my colleagues. Twitter is done in quick sound bits, but I need longwinded blog posts to even begin to explain where I’m coming from.
To me, twitter is a place where people think fiscal policy works, or (on the right) doesn’t work because nominal shocks don’t matter. Where central banks are frequently “out of ammo”. Where a change in interest rates or a QE program constitute “monetary policy”. Where negative interest rates are viewed as a “monetary policy choice”. Where moral hazard is not taken seriously.
I could try to jump into the debate, but I don’t think I’d even know where to begin. People would think I’ve just arrived from another planet, speaking some language like Klingon.
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10. May 2020 at 11:17
Scott, what is your twitter handle?
10. May 2020 at 11:41
Scott,
My experience on Twitter is that there is a pretty large community of economists who respect your ideas, and often reference you. This is even beyond the market monetarists and fellow travelers such as George Selgin. If you just follow those who follow me, you’ll see this.
I’ve been on econ Twitter, intensely for a couple of years now, and have been surprised at how open people are to arguments like yours and how often clever counter-arguments are offered, even if just from the perspective of Devil’s advocate. There are very smart people I disagree with, who I n ok nonetheless respect and acknowledge may ultimately be right.
I think you’d do just fine on Twitter, and you can always reference blog posts for more fleshed out arguments. Many others do that.
10. May 2020 at 12:43
Vaidas, I’m not on twitter.
Michael, I’m not so sure. There are definitely people who agree with me on NGDP targeting. But I find it increasingly hard to communicate on issues like what the Fed is doing right now. I’m not saying it’s impossible, but it’s really hard when limited to 280 characters.
10. May 2020 at 12:44
Michael, I could issue a bunch of zen-like cryptic koans, but who’d want to read those?
10. May 2020 at 14:31
Scott,
You said:
“Michael, I could issue a bunch of zen-like cryptic koans, but who’d want to read those?”
First, that’s funny, because I often wonder why you’re being zen instead of just being more direct.
Second, you have a large readership than most economists, so apparently there are a lot of people who like to read them.
10. May 2020 at 16:22
Twitter seems to me to be the internet version of bumper stickers: similar space for content but wider distribution. Bumper stickers were associated with sloganeering activists but were never viewed as a medium for serious discussion. With Twitter, one can issue many more bumper stickers than will fit on one’s car and have them seen by many more people that don’t have line-of-sight proximity to one’s car. But, why would wide and cheap distribution change the nature of the content? Sometimes, people criticize the level of discourse on social media, but it doesn’t seem worse than what we would have expected from the bumper sticker activists in the pre-internet days.
10. May 2020 at 17:32
here’s where you start: you can’t eat pyramids. so, you need an inviolate anchor for the value of money, lest credit create pyramids and devour the labor represented by the money distorted through greed induced imprudent credit creation. as old as the hills. join twitter and argue though that lens and redeem yourself and cancel you chardonnay subscriptions.
10. May 2020 at 22:18
Scott, I actually think you could make a big contribution on Twitter. I don’t know whether your blog views numbers have changed much over the years, but I’m guessing most visitors nowadays are regular readers. Your value on Twitter would not be to provide comprehensive alternative explanations or interpretations of events – you could still point people to your blog for that. Rather, one thing Twitter demands and enables is brevity and focus. With a single chart you could highlight how the conventional interpretation of something doesn’t make sense, and/or supports your view. For example, the ‘never reason from a X’ topic of this and many other of your posts could be brought to a wider audience very pithily – eg it may be useful to tweet a picture of a chart showing how markets have responded to policy actions commonly described in certain ways (like ‘expansionary’, ‘contractionary’ or ‘unprecedented’, etc).
Looks, it can be a waste of time and you might prefer to watch films or read books or whatever. But it’s a new and much larger audience and one that desperately needs some market monetarism!
10. May 2020 at 23:25
Scott, in all the scenarios you describe here, QE has an inflationary effect versus the counterfactual of no-QE. The fact that QE is associated with exogenous deflation in one of your scenarios is irrelevant.
I’m really confused by your argument here. Are you really claiming that QE is not reliably inflationary or disinflationary versus the counterfactual, across different scenarios? If so you might need a longer blog post, I think.
Or are you arguing that engaging in QE is not really a voluntary action taken by the central bank, and as such the whole idea of the “counterfactual” is meaningless?
Big fan of your work, btw. And twitter sucks!
10. May 2020 at 23:55
“There are other significant ‘anomalies’ that have challenged the old as well as the new mainstream approaches. While theories place great store by the role of interest rates as the pivotal variable that has significant causal force, empirically they seem far less powerful in explaining business cycles or developments in the economy than theory would have it. In empirical work, interest rate variables often lack explanatory power, significance or the ‘right’ sign. When a correlation between interest rates and economic growth is found, it is not more likely to be negative than positive. Interest rates have also not been able to explain major asset price movements (on Japanese land prices, see Asako, 1991; on Japanese stock prices, see French and Poterba, 1991; on the US real estate market see Dokko et al., 1990), nor capital flows (Ueda, 1990; Werner, 1994) – phenomena that in theory should be explicable largely through the price of money (interest rates). Furthermore, in terms of timing, interest rates appear as likely to follow economic activity as to lead it.”
http://eprints.soton.ac.uk/339271/1/Werner_IRFA_QTC_2012.pdf
11. May 2020 at 01:04
Scott, perhaps your wife could help you write Tweets in Chinese? The character limit is more generous then.
(Just joking, twitter is awful at best, and seems to bring out the worst in people. Twitter orchestrated plenty a witch hunt.)
11. May 2020 at 05:06
Twitter is an excellent diversifying location for you. Twitter permits sarcastic critique, and is an excellent place for you to express your somewhat natural ability to get very irritated at stupidity. Think of your twitter account as your “really bad” blog———and there are few better ways to broaden your audience. It is needed.
11. May 2020 at 06:53
Reporting and debate focus on changes in nominal variables without seriously considering where the “natural” variables are going. Sure, they’re harder to track, but they’re critical! Compound that with economists being imprecise in how they talk about key concepts in the field (“ceteris paribus, lower rates lead to higher inflation”…sure, but those ceteris ain’t paribus! and more importantly, “low” relative to what?).
This is how you get people freaking out about “low” rates (1% is way less than 5%, golly!), but not realizing that during a crisis a “low” rate might really be an appropriate rate, or even a high rate relative to the new natural rate- dovish changes in policy do not necessarily mean a change to a dovish policy stance.
11. May 2020 at 09:09
Thanks Rajat.
Purple Mutt, This is a subtle point. Consider this analogy. Monetary policy initiative “X”causes the equilibrium interest rate to fall by 30 basis points, while the target rate falls by 18 basis points. Policy X is contractionary. Now one might argue that the 18 basis point fall in the target rate, considered in isolation, is expansionary. But people tend to look at initiative X and only see the target rate change. They wrongly believe “X” as a whole is expansionary.
Switzerland cut its target rate in January 2015, and at the same time cut the equilibrium interest rate even more (by revaluing its currency higher in the forex market). The overall effect was contractionary.
Now suppose policy initiative X increases the monetary base by $1 trillion but increases money demand by $2 trillion. The overall effect is contractionary, even though QE is expansionary (considered in isolation), as you say.
More likely, policy X does not directly increase money demand, except in the sense of “errors of omission”. It merely fails to respond to a “shock” with proper forward guidance.
Nonetheless, I worry about people getting the wrong idea when QE programs are positively correlated with economic distress. There’s a tendency to assume that “QE doesn’t work”. It’s like assuming hospitals don’t work because death rates in hospitals are high.
I appreciate the question, as it will help me to sharpen the arguments in the paper I am working on.
Michael, Consider this to be my twitter.
Daniel, Exactly.
11. May 2020 at 10:25
Just keep doing what you’re doing, it is quite valuable. There are more of us out there than you know, on and off twitter, trying convince people to stop reasoning from a price change.
The monetary policy tide is turning, albeit too slowly.