Low interest rates do not cause low inflation, or high inflation
By Scott Sumner
I often argue that people should never reason from a price change. Interest rates are also a price. Here Noah Smith gets into trouble by considering the impact of a change in interest rates:
But what if QE had the opposite of the intended effect? That is the claim of a small but well-credentialed group of macroeconomists that I once labeled the “Neo-Fisherites,” after the famous monetary economist Irving Fisher. These economists wonder if quantitative easing reduced inflation, instead of increasing it as many feared it would. The Neo-Fisherites go even further than that — they wonder if low interest rates, which we usually think of as being inflationary, are actually deflationary!
There are two big problems with this quotation. First, the idea that QE might have reduced inflation is not an interesting hypothesis. We know that QE slightly increased inflation. What economists need to do is figure out why QE slightly increased inflation, and by how much. Raising it as a question gives uninformed readers the false idea that there is serious debate about whether QE raised or lowered the price level.
More importantly, this quotation gives readers the impression that standard macro theory tells us that low interest rates are inflationary. This is not true. Low rates caused by expansionary monetary policies are inflationary, and low rates caused by contractionary monetary policies are deflationary. But in that case it’s a waste of time to even talk about the impact of interest rates on inflation. Always focus on the effect of the thing that caused interest rates to change.