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How Loose Has Monetary Policy Been, Really?

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"How Loose Has Monetary Policy Been, Really?"


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Because I’m cool like that, for the past few weeks I’ve been listening to Robert Shiller’s lectures on financial markets as I walk around town. Appended at the end of the course turns out to be two talks Larry Summers gave on April 29 & April 30 of 2008 as the Okun Lectures on the subject of “Learning from
and Responding to Financial Crisis.”

It’s mostly interesting at this point as a historical document, i.e. Summers presciently argues that we’ll need more stimulus than what Congress has already decided to do, but somewhat non-presciently seems quite concerned about policy implementation lags, which in retrospect are the least of our problems. But he also makes some points that are still relevant today. One goes like this. Normally we discuss monetary policy in terms of the Federal Funds Rate, but if you look historically the London Interbank Offer Rate (LIBOR) tracks the Fed Funds Rate extremely closely:

(click for bigger view)

(click for bigger view)

Consequently, if you’re looking back to the past to say “monetary policy had such-and-such an impact” it’s not really clear if “monetary policy” really does denote the Fed Funds Rate or else if LIBOR is the better metric. And one of the signatures of the crisis has been a divergence between the two numbers:

(click for larger view)

(click for larger view)

The basic story of the huge spike in this spread and its subsequent decline is well known. But what I’ve heard less of is Summers’ implication that we should view the LIBOR spike as in effect a massive tightening of monetary conditions and thus the whole second half of 2008 as basically a period in which money was becoming tighter rather than, as it’s usually perceived, a period of great monetary easing (this has, of course, long been Scott Sumner’s position, though on somewhat different grounds). More disturbingly, as you can see on the chart though money really did get very easy by this standard over the winter of 2009-2010, conditions are tightening again despite the continuation of the low Fed Funds Rate.

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