Today I noticed in the FT that the German Savers lobby is complaining about rates being kept too low.  They want tighter monetary policy, because they think it will suit them.

Maybe.  Tighter monetary policy would drive down inflation, perhaps even lead to outright deflation.  In real terms, people who have cash savings will benefit from money being made more expensive.  There must have been people who even did well out of the Great Depression, and no doubt they tended to congregate.

But if savers want higher nominal interest rates, which is what I think they really need, then the worst way of achieving it is through tighter monetary policy.  As Market Monetarists tirelessly point out, tighter policy ends up lowering rates.  If you cloned perma-hawk Andrew Sentance eight times, put them all on the MPC to do what comes naturally (deliver tighter money), their attempts to raise short term rates by withdrawing money from the economy would suck out so much demand that equilibrium interest rates would hit the floor very soon after.

Market monetarism is a fairly new school of thought, but traditional monetary experts would agree. Frederic Mishkin, on pages 113-20 of his leading money textbook  makes it clear that at best the relationship between monetary easing and the level of rates is ambiguous. The liquidity effect of extra money may lower rates, but the income effect and expected inflation effect raises them.  And normally (p 116-8) it is the latter two that dominate.

Draghi also gets it: he said “we are cutting rates in order to make higher rates possible in future” (h/t Frederik).  What he means is that monetary easing now will eventually lead to higher nominal incomes, a higher and growing price level, and therefore higher rates. Even economists find this confusing; what members of the public make of this I cannot guess. (I have in my time had a go at explaining it all to some pretty bright politicians, and they always get stuck on “but what am I telling people about interest rates?”

It confuses other experts too. Look at this from McKinsey, a well respected set of consultants

How McKinsey sees QE

I became aware of this analysis (which I foreshadowed four years ago in Credit Where It’s Due) at an event where the distinguished author effectively argued that lower rates were damaging the economy.  Monetary stimulus hurts demand. If you wanted to start constructing conspiracy theories about how QE has no useful effects, and is just a plot to help the rich, you would start with their document (to be found here).  It effectively implies that the only parties helped by low rates are those unwilling or unable to spend the money (and it casts a little doubt on this leading politician’s claim in 2009 that “Bank of England rate cuts are saving British households more than £30 billion a year in interest payments”.  Only if you exclude lots of savers …)

This is why I felt real distress to read the great Simon Wren Lewis, who has taught me a great deal through his blog, saying ” monetary policy is all about using interest rates to control aggregate demand”.  Presumably, this means: lower rates and you get more demand, higher rates and you get less.   But this looks odd against history: higher growth has normally coincided with higher rates, not lower.  Conditions in the middle of 2012 were not about red-hot stimulus from the monetary channel.

Over to Lars, here: “When you say interest rates will be low – you tell the markets you plan to fail”.  Like Japan failed for decades.  If Carney promised, now, that rates would be below 2% in 5 years time, I would see this as a highly bearish signal.

Monetary policy can work when no one is borrowing at all (just imagine an economy with no banks, using gold as currency, and where they dig up a whole load more gold. Money would get a whole load easier.) Credit relations can exist in a world without money (imagine a world of pure barter: pay me with eight chickens today, or ten chickens next week).  The concepts of credit and money are different.

I think monetary policy works. It gets more difficult at the ZLB, and there is way too much purism about relying solely upon purely monetary operations. But understanding it in terms of interest rates confuses the hell out of everyone. I have no doubt that SWL can write brilliant models where seeing it purely in terms of interest rates works fine (though I think Nick Rowe’s riposte is valid: it doesn’t work for all possible worlds). However occupying the space between geniuses like Rowe and SWL and ordinary people, businesses and politicians, I think a conversation about interest rates to achieve an inflation target fails to do the job, and has led to unnecessary defeatism.

There has to be more to monetary policy than “the cost of borrowing”.  For once, actually speaking about something with different language may make a tangible economic difference.







One thought on “This is why thinking about monetary policy as “all about interest rates” is confusing

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