Monetary Policy and Semantics

When you’re an economist, you have to be very clear about your topic. Otherwise, the “mortals” (non-economists) will misjudge your judgement (and unfortunately some economists will too).

What I will talk about today is the definition of easy/tight monetary policy.

I guess this may be one of the most common “facepalms” topics by Scott Sumner, the Market Monetarist guru.

Was the fall in interest rates in 2008, monetary easing?

Were high interest rates in Weimar, contractionary?

I’ll try to make everything clear (because it really is pretty confusing) and I’ll try to avoid any mistakes…but hey, what can I do?

First of all, you would have to define a comparison point:

If you are a Keynesian, you will (most probably) call it full employment.

If you are a New-Keynesian/Wicksellian, you will call it the natural rate of interest.

If you are a Monetarist you will call it your Monetary Target.

If you are a Market Monetarist you will call it your Nominal GDP target (or wages target or whatever..).

If you are a Marxist you will call it Revolution!!

And if you are na Austrian, you’ll wonder why is the Government sticking its nose where it’s not called for.

I’ll stay with the mainstream for today, so the Natural Rate it is. (Hurray for Knut!)

Let’s imagine the Fed lowers its interest rate from 5% to 0%. What kind of policy is this? (easy=expansionary; tight=contrationary).

First of all, most people will cal it “easy money”, because 0% is “free money”, right? Wrong.

If the natural rate is below 0% we have a tight policy, if it is exactly 0% we have a neutral policy stance, and only if the natural rate is above 0% we would have an expansionary policy.

Yeah..right, but the Fed lowered its rate by 5 p.p., so the policy may not be easy, but at least the Fed is “easing it”, right? Wrong again! Imagine the natural rate has fallen by 6 p.p., and you would have the Fed tightening (2008 anybody?).

For conclusion, let’s cut some slack. We can at least say that, if the Fed reduces its interest rate (ceteris paribus) this is an easier policy than not moving the rate at all. (this is what everybody that says the above mistakes usually means).

Semantics is important! Unless you want to make economists roll their eyes.


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