Economist There is a new article discussing how interest rate hikes have failed to reduce inflation in many countries The title made me laugh:

They focus on Chile:

It seems a little unfair. In July 2021, as rate-setters in America and Europe dismissed the risk of spiraling inflation, Chile’s central bank got its act together. Concerned that inflation would rise and remain high, its policymakers voted to raise rates from 0.5% to 0.75%. The bank has raised rates repeatedly since then, beating investor expectations and taking the policy rate to 11.25%. Perhaps no other central bank has pursued price stability so diligently.

Has the star student been awarded? hard Chile prices rose 14% year-on-year in September.

And it’s not just Chile:

Economist Data collected on Chile and seven other countries where the central bank began a tightening cycle at least a year ago and did so after cutting interest rates to all-time lows early in the Covid-19 pandemic (see chart). The group includes Brazil, Hungary, New Zealand, Norway, South Korea, Peru and Poland. . . . Call the unlikely group “Hikelandia”.

Core inflation in Hylandia hit 9.5% in September, year-on-year, 3.5 percentage points higher than in March. Worse, the gap between global core inflation and the Highlander reading appears to be widening, not narrowing.

And it’s not just energy consumption:

Dig into national statistics for Highlands, and the trends become even more alarming. Chile’s wage growth is accelerating. Inflation in South Korea’s labor-intensive services sector was 4.2% a year in September, the highest since the early 2000s. Hungary’s service-sector inflation rose to 11.5% from 7.2% in the past six months. Across the club, inflation is becoming more diffuse, affecting a wider range of goods and services. 89% of the components of Norway’s inflation basket rose more than 2% year-on-year in September, up from 53% six months earlier. In research on Poland published in late September, Goldman Sachs economists found evidence that “the pace of underlying inflation has picked up again”.

The Economist thinks that the higher the interest rate, the tighter the money. I’m not sure why they didn’t mention Argentina in their article, where Interest rates and inflation Recently increased to about 70%. At no point in the essay does the economist question the assumption that high interest rates represent tight money. It seems to be taken as a matter of faith.

Unfortunately, economists are now mainstream. Twenty years ago, the conventional wisdom among economists was that interest rates did not measure the stance of monetary policy. But that is not the case anymore.

Historians of science note that when models are flawed, empirical inconsistencies begin to accumulate. Eventually, this leads to a paradigm shift and adoption of a new and improved model. In this case, we only have to go back to the mainstream financial model of 2002, with low interest rates no represented easy money and where monetary policy was “highly effective” at zero interest rates.

Some may argue that these inconsistencies point to the need to replace the flawed Keynesian model with a neo-Fisherian model, where high rates represent simple money but it merely replaces one form of “argument from price change” with another. The point is to look not at the causes of price changes, but at the causes of interest rate changes.

In 2007, the Fed did not pay interest on reserves. Instead it uses base money injection and removal as a tool to target interest rates. In late 2007 and early 2008, they lowered their target interest rate from 5.25% to 2.0%. Was that easy money? No, because they did not take any expansionary policy action to create lower rates, they simply followed the lower market. In fact the growth rate of the financial base has actually slowed sharply. (Just to be clear, the base is also not a good policy indicator because of changes in the demand for base money.) The Fed’s policy was contractionary, and the effect was much slower to increase NGDP. I suspect that if you look at old copies of the Economist, you will find that they reported that the Fed was easing monetary policy during this period.

Commentators keep asking me, “What should the Fed have done differently with interest rates?” This question drives me crazy, because it plays into the myth that interest rates are monetary policy. I have no idea whether interest rates should have been higher or lower in 2022 (or whether the monetary base should have been larger or smaller), but I am certain that monetary policy should have been tighter.

If you insist on interest rate language, I would say that rates need to be higher relative to the normal rate of interest. But this is not very informative, because a tighter monetary policy would have made the natural rate of interest much lower. Thus, I have no idea whether interest rates should have been higher or lower in absolute terms. In those Hylandia countries, it is quite clear that the normal rate of interest is rising rapidly. That’s why what seems like tight money policy to the economist, is not tight at all.

The world is divided into three camps:

1. Doves who believe the Fed has tightened too much.

2. Hawks who believe the Fed hasn’t tightened enough.

3. and a small group of heterodox economists who do not believe that rising rates represent tighter monetary policy.

All of the media are in one of the first two groups. I am in the third group. If the asymmetry continues to grow, then we should start following. But as with the liquidity trap myth, there is a danger that inconsistencies lead to worse theories:

Perhaps stopping inflation is harder than anyone could have predicted a year ago. This possibility was hinted at in a report published by the Bank for International Settlements, a club of central banks, in the summer. In a “low-inflation regime”, the norm before the pandemic, nobody paid much attention to prices, making sure they didn’t rise too fast. But in a “high-inflation regime”, such as in the 1970s, households and firms begin to track inflation more closely, leading to “behavioral changes that can bind it” over time. If the world shifts from one norm to another, different tools may be needed to cool prices.

If you slow down NGDP growth, inflation will go down – whatever “household expectations” are.

Whenever the economy begins to respond to monetary policy in ways inconsistent with mainstream theory, people begin to question the effectiveness of monetary policy. In the early 2010s, many pundits asserted that monetary policy was ineffective because the economy was weak during a period of low interest rates. Sigh. . .

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