Scott Sumner writes that he attempted to post the following comment

Karl, I’m claiming that it’s not even clear whether a forecast of higher interest rates should be regarded as bullish or bearish for the average business.  We know that rates are strongly procyclical.   I don’t see where you’ve addressed this issue.

I do agree that if one combines low interest commitments with various specified NGDP paths, it could be bullish

I realized after I wrote the post that I actually got the overall mechanism wrong.

I had said that if you are a business owner then knowledge of the interest rate path should be enough. However, this is not correct.

What is correct, is that if you know the Fed’s response function and you know the path of interest rates then you know whether policy is tight or loose.

That sounds complicated but there is a clear cut example, where it becomes clear.

Suppose the Fed said, come hell or highwater, the Federal Funds rate will be 0% until 2016.

Most of us intuit that this is unquestionably expansionary. The reason why is that the Fed has just told you what its response function looks like: the interest rate is utterly indifferent to the macro-economy.

So, now you know that low interest rates aren’t a response to low inflation. They are not a response to anything. Which means that no matter how much money demand there is the Fed will print enough money to push the interest rate down to 2016.

This is clearly expansionary.

However, if you just look at an economy from the top, with no knowledge of the response function then you can’t tell what has happened.

This is the same as if someone had said in earlier times: Oil is $100 a barrel, does that mean OPEC is tight or loose?

You can’t know right off the top because if OPEC is too tight they will crash the world economy and hence bring down the price of oil. So, high oil could mean they have been loose. Or it could mean they have just recently tightened. You don’t know.

As a note Scott also just said

It seems to me that Keynesians tend to underestimate how easy it is to stymie fiscal stimulus.  I imagine they think in terms of the Fed or ECB raising interest rates to offset the expansionary effect of more government spending.  That sort of sabotage is unlikely to occur in the near future (and least in the US; and in Europe unless in a fit of madness Trichet is put back in charge.)

Fiscal stimulus is not my personal obsession but I have noticed that the Fed is much more wavery than I had assumed and I am beginning to be concerned.

I had previously waved away such concerns on the grounds that Fed policy was asymmetrical. It was really hard for the doves to get more non-traditional monetary stimulus, but likely easy for them to prevent the Funds rate from rising.

Thus we just had to breech 0% on the natural rate and we were off to the races.

Now I am not so sure. They are being really weird in the presence of improved data. Their staff members are also going around bemoaning high rents as a sign of core inflation.

Pretty soon I am going to start hearing about how concrete and rebar shortages are a sign that the monetary transmission channel has broken down.

None of this is sensible and I am not sure what they are doing or thinking.

You had a dramatic collapse in capital expenditures as collateral values collapsed. You should expect capital input costs and rental rates to rise quite fast if you want the economy to rebuild.

If you stop this process from happening you are basically saying the economy can never rebuild, or at least can only dribble out at pathetically slow pace.

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