A few years ago, I criticized the view that rising long-term interest rates represented a tightening of monetary policy.  This was in response to Fed claims that even though they had not yet begun to raise their short-term policy rate, rising bond yields effectively tightened policy.  I think we now know that the Fed’s theory was wrong, as inflation and NGDP rose very sharply in 2022.  Policy was highly expansionary at that time and yields rose due to rapid NGDP growth.

At today’s Fed press conference, Nick Timiraos asked a very good question:

Q: Nick Timiraos of The Wall Street Journal. Chair Powell, you’ve argued over the last year that policy tightening started before you actually lifted off because the market anticipated your moves and tightened on your behalf. The market is now easing policy on your behalf by anticipating a funds rate by next September that’s a full point below the current level, with cuts beginning around March. Is this something that you are broadly comfortable with?

MR. POWELL: So this last year has been remarkable for the sort of seesaw thing back and forth we’ve had over the course of the year of markets moving away and moving back and that kind of thing. So—and what I would just say is that we focus on what we have to do and how we need to use our tools to achieve our goals, and that’s what we really focus on. And people are going to have different forecasts about the economy, and they’re going to—those are going to show up in market conditions or they won’t. You know, but in any case, we have to do what we think is right.

And, you know, in the long run—it’s important that financial conditions become aligned or are aligned with what we’re trying to accomplish. And in the long run they will be, of course, because we will do what it takes to get to our goals. And ultimately that will mean that financial conditions will come along. But in the meantime, there can be back and forth. And, you know, I’m just focused on what’s the right thing for us to do. And my colleagues are focused on that too.

In general, Jay Powell gave very cogent answers at today’s press conference.  He seemed fairly confident that the Fed was well on its way to bringing inflation back to 2% without a major recession.  But the answer to Timiraos’s question is obviously pretty weak.  If the rising market rates of late 2021 really did indicate policy tightening, then the sharply falling rates of the past 6 weeks would indicate substantial easing.  But elsewhere Powell insists that it’s too soon to ease policy, as we need clearer evidence that inflation is on track to fall back to 2%.  You can’t have it both ways.

In fact, Powell was wrong to be reassured by rising bond yields back in late 2021, and he’s right not to be concerned by sharply falling bond yields in recent weeks.  I hope the Fed never again relies on the faulty theory that movements in long-term rates are evidence of a change in monetary policy—they often reflect changes in expectations about the future path of NGDP growth.