What do people believe about interest rates?
By Scott Sumner
In this post I’ll try to describe what various groups seem to believe about interest rates. Undoubtedly I’ll get some of the nuances wrong, and I’ll try to do updates as people correct this initial post:
1. Low real interest rates are easy money and high real interest rates are tight money. Because inflation expectations have been low and stable in recent decades, for all intents and purposes nominal interest rates are now a pretty good indicator of the stance of monetary policy.
New Keynesians (and Austrians?)
2. Easy money occurs when the Fed sets short-term rates (fed funds rate) below the natural rate, and tight money occurs when interest rate targets are set above the natural rate. Because the natural rate is usually fairly slow to change, a major period of declining interest rates usually represents an easing of money policy, and substantially rising interest rates usually represent tighter monetary policy.
3. Interest rates are not a reliable indicator of the stance of monetary policy. On any given day, an unexpected reduction in the fed funds target is usually an easing of policy. However, an extended period of time when interest rates are declining usually represents a tightening of monetary policy. That’s because during periods when interest rates are falling, the natural rate of interest is usually falling even faster (due to slowing NGDP growth), and vice versa.
4. A permanent decline in nominal interest rates is usually a tight money policy, and permanently higher interest rates usually constitutes easier money.
In my view, the first two claims are partly false, the third is true, and the fourth is true but does not have the implications that NeoFisherians seem to assume it has, due to reasons explained in point #3 (unexpected rate cuts are usually inflationary.)
Thoughts? How would you characterize the different views on interest rates?