Alan Blinder thinks the interest rate trajectory defines the stance of monetary policy

Michael Darda to Scott:

Alan Blinder in today’s WSJ, arguing, as some Fed officials have, that it’s not the start/timing of the initial rate hike/tightening that matters, it’s the trajectory. This is just incredibly wrongheaded in virtually every respect. If the Fed is overlooking a passive tightening in monetary/financial conditions and a concomitant drop in the eq. short rate and then compounds it by actively tightening instead of easing, the “trajectory of short rates” will be very shallow indeed. The “path” of short rates was “only” 25 bps in Japan in 2000, “only” 50 bps in Japan in 2006/7 and “only” 50 bps in the EZ in 2011. And the outcomes were all consistent with monetary policy failure.

Memo to Blinder: Never reason from an interest rate path.

Scott comments:

This is a very important point. In the three episodes mentioned by Darda, the trajectory of interest rates was extremely flat, after the initial increase. And yet in all three cases monetary policy was far too contractionary, and in all three cases the country (or region) again fell back to the zero rate boundary. The Fed may avoid that mistake, but it won’t be because a flat interest rate trajectory means easy money. I’d guess that about 90% of interest rate movements reflect the condition of the economy, and 10% reflect Fed policy.

Blinder’s right that the future path of policy is very important, but wrong in assuming that the future path of interest rates tells us anything useful about the future path of policy.

Which reminded me of 1993-95, At that time, the Fed chose a “steep” path for the FF target rate. Was policy “tight”?

The nominal side:


Where it is hard to assign a “policy role” to the FF rate. After all, inflation fell while the FF rate was “dead” and stopped falling when the FF rate increased rapidly!

Now look at what went on with NGDP. It is clearly much more relevant to what happened to inflation.

The real side:


RGDP growth and the fall in unemployment pick up when NGDP growth rises (despite the rise in the FFT) . What the Fed successfully did was to put the nominal economy back on track after the 1990/91 recession and importantly, with a permanently lower rate of inflation. The real economy says “thanks”!

Note: Apparently, the Fed was also successful in “tracking” the equilibrium interest rate!

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