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Yes, it’s tight money

Summary:
It’s always useful to revisit Frederic Mishin’s three lesson on monetary policy, from the number one money textbook: 1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.3.  Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero. Other asset prices? We have plunging bond yields. Plunging TIPS spreads. Plunging Hypermind NGDP prediction prices. Plunging stock prices. Plunging commodity prices.

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It’s always useful to revisit Frederic Mishin’s three lesson on monetary policy, from the number one money textbook:

1.  It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.

2.  Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

3.  Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero.

Other asset prices?

We have plunging bond yields. Plunging TIPS spreads. Plunging Hypermind NGDP prediction prices. Plunging stock prices. Plunging commodity prices. Widening risk spreads. What more do you want?

How about a soaring dollar?

Yes, it’s tight money

Yes, we need to avoid reasoning from a price change. Sometimes the dollar appreciates because another currency is weak. But now the dollar is appreciating against almost all currencies. Sometimes the dollar appreciates because the US economy is strong (as during the tech boom of 1998-2000.) Does the economy seem strong today?

We are seeing a replay of almost every single market reaction from late 2008.

PS. We have lots of pundits telling us that this crisis shows that libertarianism doesn’t work and that we need big government. (Do they know that Italy has one of the biggest governments in the world?)

In fact, our government has spent months twiddling its thumbs when it wasn’t using regulations to actively prevent the private sector from responding. And now I see this:

Yes, it’s tight money

Thank God for globalization.

That’s not to say there aren’t a few areas where smart governments can contribute. Pity we don’t have one.


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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