One of the interesting things we’ve learned over the past five years is that something special happens when monetary policy hits the “lower bound” as short-term interest rates fall below zero. Not something interesting to the economy. Something interesting to politics. Suddenly, respectable circles are seized with what can only be called a passion for tighter money. A desperate yearning to find some reason—any reason—for tighter money.
The latest one is a factually questionable and logically dubious assertion that talk of “tapering” quantitative easing is killing emerging-market economies, and somehow this bolsters the case for tight money.
The first reason was the reasonable one: You used to hear that we needed tighter money to avoid inflation. That makes perfect sense, it just doesn’t happen to be true. As time went on and it became clear that it wasn’t true, people started changing the definition of “inflation.” So a return of stock prices to a level slightly above their pre-crisis peak, and a return of house prices to a level about halfway between the peak and the trough was evidence of “asset price inflation.” You might think it was evidence of a partial economic recovery. But no. Partial economic recovery isn’t a good reason for tight money. So the passion for inflation demands a redefinition. It was asset price inflation. But people like a stock market recovery, so that didn’t work. Then we got the “financial instability” argument, where the idea was that instead of using regulatory policy to prevent banking crises we would instead urge the central bank to throw the whole economy into recession as a way of policing banks.
Now emerging markets. The way the passion goes this time is this: Quantitative easing, by pushing investors into riskier asset classes, was sending foreign “hot money” into emerging markets (like Indonesia), blowing up local bubbles, and now withdrawing QE is popping those bubbles. Since we can’t keep doing QE forever, this harmful bubble-popping is an unavoidable downside of QE and evidence that we either never should have done it in the first place or else should end it the sooner the better.
Scott Sumner raises some doubts that tapering is in fact hurting Indonesia. My question is more about logic. If tapering is hurting Indonesia, why are we so sure that it isn’t the fact that tapering is being discussed despite high unemployment and low inflation that’s hurting Indonesia? I can easily see how erratic, fad-based monetary policy in the United States could create a problematic situation for emerging markets. But why leap from the damage done by inappropriately early monetary tightening to the idea that this shows tight money is good? Why not call this a secondary negative consequence of tighter money at an inappropriate time? The passion, of course. But it’s still the case that nothing has actually happened yet to in any way shake me off the simplistic view that tighter money is for times of high and rising inflation, not times of low and stable inflation.