“Normalizing” Monetary Policy should be with reference to money, not interest rates

Mike Belongia and Peter Ireland have written a nice essay on Japanese-style deflation:

One can make sense of the inflation data by looking at both interest rates and the money supply. It may be true that during normal times, when long-run inflationary expectations remain anchored, lower interest rates can signal that monetary policy has become more accommodative, putting upward pressure on prices. It seems far more likely over the past two decades in Japan, however, that the direction of causality has been reversed. Instead, interest rates are low because expected inflation has fallen: bond-holders no longer need a higher interest rate to compensate for rising prices that, if present, would erode the purchasing power of their saving. Slow money growth therefore represents the driving force behind both low inflation and low interest rates.

And conclude:

Strangely, central bankers around the world appear to have forgotten this simple lesson. Despite seeing the clear example provided by Japan, policymakers at the Federal Reserve have paid less, not more, attention to measures of broad money growth since the mid-1990s. That’s a pity. By emphasizing in public statements that they are both willing and able to use monetary policy to control the growth rate of money, Federal Reserve officials could easily reassure Americans that the United States need not ever suffer from “Japanese-style” deflation.

The corresponding US charts follow:

Japan style deflation_1

Japan style deflation_2

As Benjamin Cole loves to say: “Print more money”! Meaning that “normalizing” monetary policy should refer to money growth, not the FF target rate.


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