The association of low interest rates with loose money and high interest rates with tight money is an understandable fallacy, but as Milton Friedman pointed out it is a fallacy. The low interest rates of 1930s America and 1990s Japan were, as he said, symptoms of very tight money. His argument implies, further, that falling interest rates can coincide with and even be caused by a tightening of monetary policy.


Because of that widespread fallacy, the conventional wisdom made a major error about the economic crisis that hit in 2008 and another one about the recovery that followed. Because the Federal Reserve did not raise interest rates during 2008, the CW failed to recognize that monetary policy had disastrously tightened during that year. And because interest rates were very low (and the Fed’s balance sheet swollen) thereafter, the CW mistakenly saw monetary policy during the early years of the recovery as extremely loose. (I went into all of this in a recent article for NR that went back over the monetary history of the last ten years.)

Now we’re seeing the exact opposite mistake being made: Monetary policy is getting looser but a lot of people think it’s getting tighter because interest rates are rising. (President Trump thinks they’re rising too fast.) Scott Sumner makes the case that money is getting looser here: Whether you gauge looseness by looking at inflation, inflation and unemployment, or nominal spending, monetary policy has been turning more expansionary.


Sumner thinks monetary policy is close to neutral (as it should be) right now, and is agnostic about whether it is a little too expansionary or a little too contractionary. But I’d add that the direction in which the Fed is going is a symptom of what’s wrong with its approach to monetary policy. Monetary policy shouldn’t get looser as an economy strengthens. It should make the business cycle milder, not more extreme. But it has been doing the latter, and confusion about interest rates helps explain why.