On November 14th the McKinsey Global Institute published a report assessing the distributional effects of unconventional monetary policy. We are hosting a round-table discussion on the report and related issues. Richard Dobbs and Susan Lund, Joseph Gagnon, and Stephen King previously contributed. Up next is Scott Sumner, professor of economics at Bentley University.

RICHARD DOBBS and Susan Lund have written a report evaluating the impact of QE:

Actually, monetary policy has been highly contractionary since 2008. Yes, interest rates are quite low, and a lot of money has been injected in the economy. But that was also true in the 1930s in the US and in the early 2000s in Japan. It does not indicate easy money, as Ben Bernanke noted 10 years ago:

The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don’t really have anything satisfactory to replace it. As emphasized by Friedman...nominal interest rates are not good indicators of the stance of policy...The real short-term interest rate...is also imperfect...Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

If one uses nominal GDP growth as the criterion, then since 2008 monetary policy has been tighter than any period since the early 1930s. Indeed this is even true if you average NGDP growth and inflation. Unfortunately, Dobbs and Lund are expressing the majority view; indeed, even Ben Bernanke now considers monetary policy to be highly accommodative, despite his 2003 statement.

Some might argue that this is just a question of semantics. Who cares whether monetary policy is called "easy" or "tight"? Here's the problem. If you misdiagnose the stance of monetary policy, you are almost certain to misdiagnose the impact. Dobbs and Lund ask why lower interest rates have not spurred more investment. In fact, economic theory does not predict that lower interest rates will encourage more investment, just as economic theory does not predict that low prices will be associated with higher consumption. Never reason from a price change.

The highly contractionary monetary policy of the last five years has dramatically reduced nominal GDP growth, and this has caused much lower interest rates. In supply and demand terms, the investment schedule or the demand for loanable funds schedule has shifted to the left, depressing interest rates and also the quantity of money borrowed. If this had been caused by an easy money policy, then the low interest rates would be associated with higher levels of borrowing and investment.

Dobbs and Lund speculate that the policy of QE has helped governments by lowering the cost of borrowing. In fact, the highly contractionary policy of the last five years has severely hurt the finances of governments. Yes, their borrowing costs have fallen in nominal terms. However the impact of tight money on taxes and spending has more than offset any gains from lower interest rates. QE may have helped governments a little bit, but only by virtue of making monetary policy a bit less contractionary than otherwise.

Toward the end of their paper they make the following prediction:

Looking at the distributional impact of QE sheds light on the risks we may face in the future if and when these policies are unwound. We calculate that governments could face a 20% rise in their debt-service costs if interest rates rise back to 2007 levels—and rates even then were not very high. For the United States, this would add $75 billion annually to debt interest payments. Household savers may benefit, but the housing recovery could suffer.

If we did see interest rates rise back to 2007 levels, it would almost certainly reflect much more rapid nominal GDP growth than is currently expected. The gains to borrowers (governments, businesses, and individuals) from the faster nominal GDP growth would greatly exceed the losses from higher interest payments. As a general rule higher interest rates are associated with robust economic growth (nominal) and low rates reflect weak growth. It's a mistake to evaluate the impact of interest rates on the economy. What economists need to do is evaluate the impact of the factors that cause interest rates to change. Especially nominal GDP growth.