Low Interest Rates Aren’t “Easy” Money

The St. Louis Federal Reserve Bank’s FRED and ALFRED databases are some of the most impressive things happening in the public sector today. Unfortunately the president of the St. Louis Fed, James Bullard, has also recently become a really problematic actor in American monetary policy. Yesterday, amid America’s fourth consecutive year of low inflation and high unemployment, he delivered a talk on the theme “U.S. Monetary Policy: Still Appropriate” that not only misdiagnosed the current situation, but mischaracterized what current U.S. monetary policy is by saying, “[T]he current stance of monetary policy is ultra-easy, and remains appropriately calibrated given the macroeconomic situation in the U.S.”

The fallacy of identifying current monetary policy as “easy” or even “ultra-easy” is based on the confusion of thinking that low interest rates are evidence of easy money rather than a tool that central banks sometimes use to create a situation of easy money.

But the claim is quite easily refuted by considering two episodes from American history, the Great Depression of the 1930s and the Great Inflation of the 1970s. Interest rates were quite a bit higher in the ‘70s than they were in the ‘30s. But in the ‘70s inflation was high and rising, whereas in the ‘30s we had deflation. So do we really want to say that the greatest inflationary episode of the 20th century happened despite tight money, and the greatest deflationary episode of the 20th century happened despite easy money? Words are tools, and we can use them that way if we want, but it’s an extremely confusing way to talk. Easy—or dare I call it “ultra-easy”—monetary policy is the kind of monetary policy that leads to inflation, whereas tight monetary policy is the kind of monetary policy that leads to deflation.

Today we don’t have inflation like the 1970s, so it must be the case that monetary policy isn’t as easy as it was back then. Not even close. But interest rates are much, much lower than they were in the ‘70s, which just goes to show that while rates are a tool central banks use, they’re not a good indicator of the stance of policy.

The circumstances that face us in 2012 are considerably brighter than those of 80 years ago. Unemployment is at 8.2 percent and slowly falling rather than at 20 percent and rising. Inflation is running between 1 and 2 percent rather than below zero. But broadly speaking it’s a similar situation to the situation of the 1930s. Unemployment has been persistently higher than at any time in the postwar period, and inflation has been not just lower than in the 1970s, but lower than it was in the 1980s or 1990s as well. The central bank has chosen to put a priority on maintaining an unusually low level of inflation by guaranteeing a low level of resource utilization. And what’s particularly disturbing is that some of the people with power over this choice don’t seem to understand what they’re doing.