Interpretation and the model
Following the Jackson Hole speeches there was this post over at Uneasy Money. The money section for me is:
The reductions in long-term interest rates reflect not the success of QE, but its failure. Why was QE a failure? Because the only way in which QE could have provided an economic stimulus was by increasing total spending (nominal GDP) which would have meant rising prices that would have called forth an increase in output. The combination of rising prices and rising output would have caused expected real yields and expected inflation to rise, thereby driving nominal interest rates up, not down. The success of QE would have been measured by the extent to which it would have produced rising, not falling, interest rates.
Now this is an interesting quotation for me. There is one thing I think I know – and that is that market interest rates are very hard to interpret, given the number of different things they are representing!
This quote argues with the simplified standard economic model that is put out there. In that model, when there is an output gap central banks aim to get the realise real interest rate below its “natural level”, taking from this paper we have:
Thus, the mechanism through which monetary policy influences aggregate demand can be thought of as working as follows: Given the sluggish adjustment of prices, by varying the short-term nominal interest rate, the central bank is able to influence the short-term real interest rate and, hence, the corresponding real interest rate gap. Through its current and expected future policy settings, the central bank is able to affect the corresponding path of [the short term real interest rate gap] and, in turn, influence the long-term real rate gap … and the gap in Tobin’s q.
In this setting, monetary policy works by pushing down real interest rates (which happens by boosting inflation expectations and lowering the nominal interest rate) and by boosting aggregate asset prices.
But it is also true that if monetary policy “succeeds”, long term interest rates should be representative of the “natural” rate of real growth and inflation (as well as including factors for risk and time preference) … essentially the long term real interest rate is a constant.
From what I can tell, the afformentioned quote by Uneasy money relies on two things outside the basic model:
- A central bank sets expectations of nominal income growth, not inflation
- There are multiple equilibrium in the macroeconomy, making unemployment of the current sort the result of a failure in a co-ordination game.
However, if anyone has any more insight that can tie these view together, I would appreciate hearing it in the comments.