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I just saw Richard Clarida on CNBC, saying something to the effect that “The bond market is doing the Fed’s job for it”.

No, no, a thousand times no!!! Interest rates are not monetary policy. Interest rates plunged in 2008, but the bond market wasn’t doing the Fed’s job for it. Interest rates plunged in 1929-32. Interest rates are not monetary policy.

Cameron Blank directed me to this Jason Furman tweet:

To be clear, I do not have any problem with Furman’s general view on the current stance of monetary policy, or on the Fed’s decision yesterday. We have similar views. But the sharp fall in long-term rates does not make money easier, it probably makes it tighter.

Here are some things to consider:

Lower fed funds rates achieved through open market purchases are expansionary. M increases.

Lower IOR for any given monetary base is expansionary. V increases.

Lower bond yields for any given IOR and monetary base level is probably contractionary (depending on forward guidance.) Base velocity decreases.

Think of it this way. If you lower the yield on bonds, you probably reduce velocity. If the money supply is unchanged, NGDP tends to fall.

To a very great extent, monetary policy is (hopefully) skillfully adjusting the fed funds target in response to changes in the (unobservable) natural interest rate. A sharp fall in bond yields on a day when the fed funds rate is not adjusted is often a sign that the natural interest rate has fallen, making money effectively tighter. A sign that you are “behind the curve”.

Lower interest rates are not “good for the economy”; that’s reasoning from a price change. It depends on why interest rates are changing.

If I’m wrong, then what would you expect if bond yields fall another 50 basis points tomorrow? Would that be bullish news?

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