Here’s John Cochrane:
An audience member asked a very sharp question: Suppose the Fed raises interest rates but does not raise the rate on reserves? Now, banks do have an incentive to lend them out instead of sitting on them. Wouldn’t velocity pick up, MV=PY start to work again, and the Fed get all the “stimulus” it wants and then some?
It’s a particularly sharp question, because it gives sensible-sounding mechanism why the conventional sign might be wrong: why raising rates now might give monetary “stimulus” that is otherwise so conspicuously lacking. There are a few other of these stories wandering around. One: Low rates are said to discourage retirees and other savers, who now “can’t afford to spend.” (Quotes around things that don’t make much economic sense.) John Taylor, wrote a very provocative WSJ oped, (too subtle to summarize in one sentence here) and also came close to saying the sign is wrong and higher rates would be more stimulative.
But is the suggestion right? I sort of stammered, and needed the weekend to think it through. (Giving talks like this is a great way to clarify one’s ideas. Or maybe this just reveals my shocking ignorance. In any case, it makes a good exam question.) Think about it, and then click the “read more.”
Become a market monetarist and free up your weekends! In fairness, the Cochrane “read more” gets it right–no need to check.
On a serious note, it’s discouraging to see Cochrane continue to insist that QE does nothing, while the markets continue to scream that the Fed’s decisions on QE are the most important thing in the universe right now. Either reserves and T-securities are not perfect substitute, or else the Fed is sending signals about future Fed policy, when reserves and T-securities will no longer be prefect substitutes. More likely both.
HT: Tyler Cowen