Probably, but not tight enough.
In recent months, I’ve expressed skepticism about the claim that the Fed has been tightening monetary policy since last fall, via forward guidance. In my view, most of the increase in interest rates over the past year is due to the Fisher (expected inflation) effect, not the liquidity effect of tight money.
But in the past few weeks there is some evidence that monetary tightening might be beginning to take hold. Consider:
1. Five-year TIPS spreads peaked at 3.59% on March 25th, and have since fallen to 2.88%.
2. Ten year bond yields peaked at 3.12% on May 6th, and are down to 2.78%.
3. Stocks have fallen sharply in recent weeks.
4. The dollar has appreciated significantly in recent weeks.
I define a contractionary monetary policy as a policy stance that slows expected nominal GDP growth. We don’t have a perfect measure of market expectations for NGDP, but each of the four data points above provide some indication of where things might be headed.
1. TIPS spreads are correlated with market forecasts of inflation. Unfortunately, inflation and NGDP don’t always move in the same direction, due to supply shocks.
2. Nominal bond yields are the sum of expected inflation and real interest rates. Because real interest rates are somewhat correlated with real GDP growth, longer-term bond yields are correlated with expected NGDP growth. Lower bond yields usually imply lower expected NGDP growth. Unfortunately, a tight money policy can sometimes boost long-term bond yields in the short run, due to the liquidity effect.
3. Stocks are somewhat correlated with expected real GDP growth. Unfortunately, the stock market is noisy, and hence stock movements should be interpreted with caution.
4. A tight money policy tends to appreciate a currency, although currencies move around for other reasons as well.
Thus all 4 indicators that I cited are somewhat imperfect. Nonetheless, all four have recently been moving in a direction consistent with tighter money, which is a pretty strong indication that monetary policy has been getting at least a bit tighter.
Even so, policy is still too tight loose, at least relative to the Fed’s 2% average inflation target.
PS. This Bloomberg piece caught my eye:
After a violent rally in bonds, Treasury traders are debating whether recent tough talk from the Federal Reserve on its commitment to cooling prices is enough to reverse the trend.
I wonder if the opposite isn’t true. Perhaps it’s the recent tough talk from the Fed that is driving down bond yields and driving up bond prices.
PPS. What about a recession this year? No one is able to predict recessions. Right now, markets seem to be predicting continued economic growth, slowing over time. But that forecast could change quite rapidly.
READER COMMENTS
Chris
May 22 2022 at 1:46pm
I think you meant to say “policy is still too loose” in the last paragraph before the ps
Jose Pablo
May 22 2022 at 4:10pm
I though the same.
So, policy should/will be tighter lowering future NGDP and so:
1.-TIPS spread and 10 years bonds should keep falling
2.- Stocks should keep falling
3.- The dollar will keep appreciating
Is this an “academic” opinion or are you betting actual money on it?
Scott Sumner
May 22 2022 at 5:43pm
Thanks, I corrected it.
Steve Brecher
May 22 2022 at 3:54pm
Are recent/current rising prices the result of monetary inflation or of supply shock(s)?
Scott Sumner
May 22 2022 at 5:44pm
Clearly both.
Thomas Lee Hutcheson
May 22 2022 at 4:14pm
So what is your recommendation in the short run, absent an NGDP futures market? What is your preferred instrument to move, if any?
Scott Sumner
May 22 2022 at 5:45pm
Sell bonds.
marcus nunes
May 22 2022 at 4:45pm
The 64k question: What does “tightening enough” means?
https://marcusnunes.substack.com/p/misleading-propositions-and-rules?s=w
Scott Sumner
May 22 2022 at 5:45pm
Enough to get expected NGDP growth down to the 3% to 4% range.
EconStudent
May 22 2022 at 10:08pm
Professor Sumner,
I am looking for an accurate source for NGDP data. Would you consider CEIC’s de-annualized NGDP data to be reliable? If not, what do you consider to be the best?
Scott Sumner
May 24 2022 at 2:57pm
The BEA has detailed data. I also use FRED.
Radford Neal
May 22 2022 at 10:40pm
You say, “Stocks are somewhat correlated with expected real GDP growth.”
Why real, rather than nominal, GDP growth? If real GDP growth were zero, I would still expect stocks to go up if inflation (and hence NGDP growth) were high – a general increase in prices should (other things being equal) lead to the prices of company shares going up along with everything else…
Scott Sumner
May 23 2022 at 1:46am
Yes, stocks are positively correlated with the price level, but they are negatively correlated with the rate of inflation. Because the price level changes only gradually over time, inflation has a stronger effect in the US, at least for short run movements in stock prices.
Jose Pablo
May 23 2022 at 5:09pm
“a general increase in prices should (other things being equal) lead to the prices of company shares going up along with everything else…”
A “general increase in prices” can mask significant changes in relative prices. For instance between the price of the products that the company sells vs the price of the products the company buys.
Change in relative prices during an inflationary period (and in general) could have any impact (positive, negative or none) on margins (even leaving apart price stickiness and “menu cost effects”).
Spencer Bradley Hall
May 23 2022 at 10:11am
The demand-side pressures, Irving Fisher’s distributed lag effect, began to decelerate in the 1st qtr. as long-term money flows rate-of-change fell (proxy for inflation). Contrary to Powell, higher interest rates are not evidence of “tight” money (a deceleration in AD). And now supply-side pressures are falling as inventories are too high (and job postings are falling).
The widely held Keynesian misconception that a tight money policy results in high interest rates and vice versa derives from the premise that interest rates are determined by the demand for and the supply of money — rather than the demand for and the supply of loan funds.
Interest, as our common sense tells us, is the price of obtaining *loan- funds*, not the price of *money*. The price of money is the inverse of the price level. If the price of goods and services rises, the “price” of money falls.
Interest rates in any given market at any given time is the result of the interaction of all the forces operating through the supply of, and the demand for, loan-funds.
Loan-funds, of course, are in the form of money, but there the similarity ends. Loan-funds at any given time are only a fraction of the money supply – that small part of the money supply which has been saved and is offered in the loan credit markets.
There is no quick fix for long-term money flows. Any decline in long-term money flows, or broad-based prices, comes at the expense of short-term money flows, proxy for real output.
Capt. J Parker
May 23 2022 at 10:27am
10 year minus 3 month treasury spread still pretty high – signaling recession not likely.
Does this also signal money really not that tight?
Scott Sumner
May 23 2022 at 10:35am
Maybe, but interest rate futures do show that the spread is likely to narrow sharply over time.
Spencer Bradley Hall
May 23 2022 at 2:28pm
There is no “Fool in the Shower”. Without a contraction in the money stock, there will be no recession this year. Contrary to economic theory, & Nobel laureate, Dr. Milton Friedman and Anna J. Swartz (“Money and Business Cycles”), monetary lags are not “long & variable” (A Monetary History of the United States, 1867–1960, published in 1963).
The 10mo rate-of-change in short-term money flows, the volume and velocity of money, the proxy for real output in American Yale Professor Irving Fisher’s truistic “equation of exchange” bottomed in the 1st qtr. of 2022. Atlanta gDpNOW latest estimate: 2.4 percent — May 18, 2022
The 24mo rate-of-change, the proxy for inflation, peaked in January. Any subsequent deviation from demand-side pressures, is due to supply-chain shortages. The FED tools can’t fix supply problems.
The prospect is for secular stagnation. “The belief is that the U.S. economy can’t grow faster than 1.9% over the long term because the U.S. population is aging and demographics is destiny.”
Jose Pablo
May 23 2022 at 5:00pm
“… demographics is destiny”
Regulation, taxes and immigration are not.
Spencer Bradley Hall
May 24 2022 at 9:29am
“the aggregate RRP balance throughout 2022 has continued to rise – reaching $2 trillion for the first time just today – bank reserves have contracted by a whopping $919 billion (-21.5%) since that previous peak nearly six months ago”
milljas
May 25 2022 at 8:28am
Nice to see while we all wait for those NGDP Futures traders resumes to hit the market.
How do you interpret commodity prices or why do you not include them here? Too influenced by supply? Is it possible to look at something like the Goldman S&P index which is a mix of metals, foods and materials? Some prefer to look at the “industrial metals” sub-index of that benchmark though that might present issues because incremental demand for things like copper can be heavily influenced by China.
Thanks for this, I believe I had asked a question on this topic on another post.
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