Bond Rates

August 30, 2010

As an empirical matter, low interest rates are a sign that monetary policy has been tight― in the sense that the quantity of money has grown slowly; high interest rates are a sign that monetary policy has been easy― in the sense that the quantity of money has grown rapidly. The broadest facts of experience run in precisely the opposite direction from that which the financial community and academic economists have all generally taken for granted.

Paradoxically, the monetary authority could assure low nominal rates of interest― but to do so it would have to start out in what seems like the opposite direction, by engaging in a deflationary monetary policy. Similarly, it could assure high nominal interest rates by engaging in an inflationary policy and accepting a temporary movement in interest rates in the opposite direction.

-Milton Friedman, “The Role of Monetary Policy” (1968)

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