Monetary policy is becoming too tight

24th May 2019 Off By binary
Monetary policy is becoming too tight
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The escalating trade war seems to be sharply depressing the Wicksellian equilibrium interest rate. Here are some recent headlines, from Bloomberg:

The 5-year bond yield is down to 2.10%, a pretty clear indication that significantly lower interest rates lie ahead. Trump may or may not have been right that lower interest rates were called for in 2018 (I doubt it, as NGDP growth has been quite strong), but if the trade war keeps escalating then he will almost certainly be right about the need for lower rates in 2019.

[Yes, a determined President can “force” the Fed to cut rates, if he’s willing to wreck the economy.]

Just a month ago, the main argument for lower rates was that trend inflation was a few tenths of a percent below the Fed’s target; now the justification is much stronger—increasing risks of a global slowdown.

Given that the Fed has been “behind the curve” for most of the past decade, I’d strongly suggest that they try to get ahead of the curve. Cutting interest rates won’t work if they remain behind the curve, i.e., if rates are cut more slowly than the equilibrium rate falls. That was their mistake in 2007-08. Cut them sharply enough so that 30-year yields rise.

Short term interest rates are going to fall either way, but you’d like a “good fall” in rates (expansionary monetary policy) not a “bad fall” in rates (recession.) It’s like someone who is genetically predisposed to get colon cancer. They are definitely going to go to the hospital. But it would be better to go for a colonoscopy than wait until later and go for surgery on a softball-sized tumor.

PS. Off topic, this interesting article relates to my recent post on the Aussie election:

The result has dumbfounded the inner urban elites of government, the bureaucracy, media and industry, many of whom are in denial or seeking therapy. Most important, it has helped draw a new geography of political boundaries based not on long standing ideologies of labour or capital, or of class, but of location and privilege. A more complete reversal of traditional party allegiances would have been impossible to imagine before last weekend. As observed by The Sydney Morning Herald, “The Queensland seat of Capricornia is a perfect illustration. It has many coal-mining workers and was held almost steadily by Labor from the 1960s until 2013, yet as of today it is a much safer Coalition seat than Josh Frydenberg’s well-heeled Kooyong, which was (conservative Prime Minister Robert Menzies’ old electorate.”

Crazy. As if a long time Democratic state like West Virginia were to go Republican.

PPS. Apologizes that I have recently been slow to approve new comments. Travel, bad cold (fever), etc.

PPPS. Conservatives used to say that low rates should not be provided to bail out Obama’s bad economic policies. What do they say today?

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