Friday, 19 July 2013

Interest rates are still a bad indicator of monetary policy

A small rise in short term rates can do a lot of harm, and in economics that was a point that conservatives emphasized [conservatives the type not the political party].

Even small increases in interest rates in the US [1937], Japan [2000 and 2006], and Europe [2011] drove each economy right back into deflation and/or depression.

Monetary policy has probably become easier over the past few months, because we lack a GDP futures market. But consider that stock prices have not changed much in the last few months, and the interest rate at which future cash flows are discounted has risen substantially. We can infer that expected future nominal cash flows are now larger than a few months ago. This doesn’t mean that expected future GDP has risen, but that seems likely.

I’m still puzzled by the response of long term rates to the tapering talk. But if long rates always moved the same way in response to monetary news, then interest rates would no longer be a bad indicator of monetary policy.

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