Probably, but not tight enough.

In recent months, I have expressed skepticism about claims that the Fed has been tightening monetary policy since last fall through Forward Guidance. In my view, most of the interest rate hikes in the last one year have been due to the effect of Fisher (expected inflation), not the liquidity effect of tight money.

But in the last few weeks there has been some evidence that financial austerity may have begun to take hold. Considerations:

1. The five-year TIPS spread peaked at 3.59% on March 25, and has since dropped to 2.88%.

2. Ten-year bond yields peaked at 3.12% on May 6, and dropped to 2.78%.

3. Stocks have declined sharply in recent weeks

4. The dollar has risen significantly in recent weeks.

I define a contractionary monetary policy as a policy position that slows the expected nominal GDP growth. We do not have an accurate measure of market expectations for NGDP, but each of the above four data points gives some indication of where things could go.

1. TIPS Spread is related to the market forecast of inflation. Unfortunately, inflation and NGDP do not always go in the same direction due to supply shocks.

2. The yield of a nominal bond is the sum of the expected inflation and the actual interest rate. Because real interest rates are somewhat related to real GDP growth, long-term bond yields are related to expected NGDP growth. Low bond yields generally mean lower expected NGDP growth. Unfortunately, a tight monetary policy can sometimes increase the yield on long-term bonds in the short term, due to the liquidity effect.

3. Stocks are somewhat related to the expected real GDP growth. Unfortunately, the stock market is noisy, and so the stock movement should be interpreted with caution.

4. A tight monetary policy appreciates a currency, although currencies revolve around other factors.

Thus all 4 indicators that I cite are somewhat incomplete. Nonetheless, all four have recently moved in a direction consistent with austerity measures, a strong indication that monetary policy is becoming at least somewhat tougher.

Nevertheless, the policy is still very tight, at least compared to the Fed’s 2% average inflation target.

PS This Bloomberg piece Catch my eyes:

After a violent rally in bonds, Treasury traders are debating whether the recent tough negotiations on cool price promises from the Federal Reserve are enough to reverse the trend.

I wonder if the opposite is true. Probably a factor as to why they’re doing so poorly.

PPS. What about a recession this year? No one is able to predict recession. At the moment, markets seem to be predicting continued economic growth, slowing down over time. But that prediction could change quite quickly.

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